Introduction
This paper is based on the discussion of the article “Inflation and Debt’ by John Cochrane. In this paper, different concept presented in the paper will be presented and discussed. One of the concepts, discussed in the paper, is inflation. The central question related to inflation is the value of paper money. It is argued that the paper has money because the government accepts currency in the form of tax payments. The retailers and service provides charge money on their products and services because they are required to pay taxes (Barney, Dwayne, and Harvey pp. 97).
Summary of Articles
Money supply can be defined as the amount of money, which is available in an economy in order to purchase goods and services. The term money supply refers to currency in circulation and foreign currency deposits. The central bank of a country is responsible in order to control the supply of money in an economy. The transmission of excess money, in an economy, involves transmitting more money from financial markets to consumers. This results in an increase in the demand of goods and services. The increase in the demand for products and services exerts pressure, which moves in the upward direction. This pressure leads towards an increase in the prices of goods and services (Barney, Dwayne, and Harvey pp. 97). The increase in the demand from consumers also results in an increase in imports. This phenomenon is associated with exchange rate because it causes downward pressure on it. The pressure on the exchange rate is increased in order to balance import bills. This process leads towards a further increase in inflation (Barney, Dwayne, and Harvey pp. 97).
There are several ways through inflation affect debt. These ways include unanticipated inflation, changes in the debt’s market value, and financial repression. For many years, inflation has been considered and treated as a debatable topic. The debate focuses on the Federal Reserve (Barney, Dwayne, and Harvey pp. 97). The particular focus is on the role of FED in increasing the supply of money in an economy. The interest rates set by FED is also a topic of concern. The enormous debts and deficits of the government result in a substantial increase in inflation. If people start believing that the government will print more currency in order to cover their deficit, they assume that the rate of inflation will rise in the future. This is an important argument made by author in the article.
Authors main Claim
The enormous debt and deficits could result in a substantial amount of inflation in the United States. The belief of the people regarding future inflation would increase the inflation in the current time (Bernanke pp. 2). John Cochrane, in this paper, argued that inflation takes place when the government publishes more money than what is required. When this occurs, people try to get rid of extra money (Bernanke pp. 2). The things that people can purchase are limited. Hence, in order to cover for the additional money, the government is pushed to increase the prices of products and services. The government takes different measures in order to control the extra amount of cash, which has been floated in the economy (Bernanke pp. 2). One of these measures is to sell bonds. However, the bonds are just the promise of paying back extra dollars in the future. The government is required to soak up extra dollars by several other ways. If the government fails to do so, inflation takes place (Bernanke pp. 2).
John Cochrane has also explained the link between future inflation and the issuance of bonds. The fear of deficit, in the future, also increases the chances of inflation in the current economy. The government of the United States is largely funded by short-term debt. A large number of outstanding debts will mature in the future. When the government pays the debt, which has been matured, the debt holders receive money. The money received by the debt holder is, usually, invested to buy new debt. The real assets are limited; therefore, it is important that someone holds stock. In this scenario, an increase in the prices of real assets takes placed. At the same time, the spending of people on buying goods and services also increase. Eventually, an increase in prices takes place.
The concept of present value is very much associated with this scenario. The debt value of the government is equal to the expectations of the investor regarding the future surpluses. The surpluses are run by the government in order to pay the debt. If investors assume that the amount of surplus is small, the government defaults. When the long-term debts are outstanding, the investors sell long term (Bernanke pp. 2).
In this way, it can be agreed that inflation takes place because of the expectations of people regarding inflation in the future. The short-term bonds are often preferred over long-run bonds since the rates of interest of short-run bonds are low-down. The long-term debts have higher rates because they are insured. An expansion in rates of interest could similarly continue inflation nowadays, exacerbating the incendiary affect of a possible debt emergency in the same manner (Bernanke pp. 2).
The decrease in the interest rates is somewhat a consequence of the Fed's deliberations. Throughout the previous year, the Fed purchased a large portion of Treasury's bond issues. This was an effort to increase the price of bonds and decrease the rate of interest. The desire of FED is to keep rates this low in the future. Low interest rates are likewise an impression of ' "flight to quality. Investors agree that the United States will never default. They also agree that the United States will not miss any payment (Bernanke pp. 2).
A rise in interest rates can expedite the rate of inflation in the same way as the perspectives of investors regarding long-term debts (Bernanke pp. 2).
Present values are helpful in clarifications of different issues. Assuming that investors chose they were no more satisfied to earn 1% when loaning to the government (Bernanke pp. 2). Bank reserves are exceptionally liquid. Hence, the Fed can influence financial issues and the price level (Barney, Dwayne, and Harvey pp. 97).
The ability of Fed to control inflation in the economy depends on the ability of the treasury to implement the strategies and actions of Fed. If Fed has suggested an increase in the interest rate in order to decrease inflation, it is important for the Treasury to increase revenues. In the 1980, the decrease in the rate of inflation was induced by monetary tightening. The government of the United States repays at a higher rate to the holders of the bond. According to Keynesian and Monetarist view, the FED controls the price level. These theories are based on the assumption that there is coordination between monetary and fiscal policy. However, this assumption is not true in the practical environment. It is because the treasury does not always provide the revenue required to implement monetary policy. The theories of economics often fail because their assumptions do not always come true (Bildirici, Ozgur, and Elcin, pp. 79).
Inflation is an expansion in the normal level of prices for goods and services in an economy, over a time of time. In other way, we can say it is a file, which demonstrates how prices of goods and services that are illustrative of the economy in general are developing. The point when the general value level climbs, every unit of coin purchases fewer goods and services. Thus, inflation likewise reflects erosion in the buying force of cash – a misfortune of genuine esteem in the inside medium of trade and unit of record in the economy. A boss measure of value inflation is the inflation rate, the annualized rate change in a general cost record over the long haul. Inflation's effects on an economy are different and might be synchronously positive and negative. Negative effects of inflation incorporate a reduction in the genuine esteem of cash and other monetary things after some time, questionable matter over prospective inflation, which might demoralize speculation and investment funds, and if inflation is quick enough, deficiencies of goods as customers start worrying that prices will increase. Positive effects incorporate guaranteeing national banks can change nominal interest rates and empowering venture in non-monetary capital projects (Faraglia and Elisa et al pp. 16).
Inflation is an expansion in the normal level of prices for goods and services in an economy, over a time of time. In other way, we can say it is a file, which demonstrates how prices of goods and services that are illustrative of the economy in general are developing. The point when the general value level climbs, every unit of coin purchases fewer goods and services. Thus, inflation likewise reflects erosion in the buying force of cash – a misfortune of genuine esteem in the inside medium of trade and unit of record in the economy. A boss measure of value inflation is the inflation rate, the annualized rate change in a general cost record over the long haul. Inflation's effects on an economy are different and might be synchronously positive and negative (Bildirici, Ozgur, and Elcin, pp. 79). Negative effects of inflation incorporate a reduction in the genuine esteem of cash and other monetary things after some time, questionable matter over prospective inflation, which might demoralize speculation and investment funds, and if inflation is quick enough, deficiencies of goods as customers start storing out of worry that prices will increase. Positive effects incorporate guaranteeing national banks can change nominal interest rates (and empowering venture in non-monetary capital projects (Faraglia and Elisa et al pp. 16).
Inaction can abet debt through certain channels such as unanticipated inaction, financial restraint joined together with inaction, and by means of progressions in the business sector quality of debt. I advance a theoretical system keeping in mind the end goal to follow how those channels can be measured independently and together (Bildirici, Ozgur, and Elcin, pp. 79).
While it is not conceivable to specifically observe inaction expectations and quantify the ejection of financial restraint on business sector investment rates, I demonstrate that the net effects of these channels must be huge at whatever point true investment rates are negative (Bildirici, Ozgur, and Elcin, pp. 79).
In order to understand the association between debt and inflation, it is important to understand channels through which inflation affect debt. Researchers assume that a higher inflation rate erodes the debt value. However, financial repression is an important channel through which the debt of the government can be reduced. Financial repression is an important channel which describes the association between debt and inflation (Bildirici, Ozgur, and Elcin, pp. 79).
Conclusion
It can be concluded that the increase in money supply has an impact on macroeconomic stability and exchange rate. The increase in money supply can take place through both direct and indirect channels. However, through both these ways, the rate of inflation is increased.
Works Cited
Barney, L. Dwayne, and Keith D. Harvey. “Using Corporate Inflation Protected Securities to Hedge Interest Rate Risk.” Journal of Applied Corporate Finance 21.4 (2009): 97–103.
Bernanke, B. S., Financial Reform to Address Systemic Risk, (2009), pp. 2March Retrieved from http://www.federalreserve.gov/newsevents/speech/bernanke20090310a.htmS, Dated 11th November, 2013
Bildirici, Melike, Ozgur Omer Ersin, and Elcin Aykac Alp. “An Empirical Analysis of Debt Policies, External Dependence, Inflation and Crisis in the Ottoman Empire and Turkey: 1830-2005 Period.” Applied Econometrics and International Development 8.2 (2008): 79–100.
Faraglia, Elisa et al. “The Impact of Debt Levels and Debt Maturity on Inflation.” The Economic Journal 123.566 (2013): F164–F192.
