The Debt–Inflation Cycle and the Global Financial Crisis
| Date | 01 May 2011 |
| Author | Peter J. Boettke,Christopher J. Coyne |
| Published date | 01 May 2011 |
| DOI | http://doi.org/10.1111/j.1758-5899.2011.00088.x |
The Debt–Inflation Cycle and the
Global Financial Crisis
Peter J. Boettke and Christopher J. Coyne
George Mason University
Abstract
Writing over 230 years ago, Adam Smith noted the ‘juggling trick’ whereby governments hide the extent of their
public debt through ‘pretend payments’. As the fiscal crises around the world illustrate, this juggling trick has run its
course. This article explores the relevance of Smith’s juggling trick in the context of dominant fiscal and monetary
policies. It is argued that government spending intended to maintain stability, avoid deflation and stimulate the
economy leads to significant increases in the public debt. This public debt is sustainable for a period of time and can
be serviced through ‘pretend payments’ such as subsequent borrowing or the printing of money. However, at some
point borrowing is no longer a feasible option as the state’s creditworthiness erodes. The only recourse is the
monetarization of the debt which is also unsustainable due to the threat of hyperinflation.
Policy Implications
•The fear of deflation on the part of policy makers has led to an inflationary bias which neglects or underestimates
the costs of inflation.
•The debt–inflation theory of economic crises must be considered as a viable alternative to the standard
debt–deflation theory of economic crises.
•In order to curtail the tendency of using the tools of monetary and fiscal policy to concentrate benefits and
disperse costs, policy institutions must effectively tie the rulers’ hands.
•After centuries of only fleeting success at curtailing the deficit, debt and debasement cycle of public policy, we
may have to consider seriously the possibility that the only way successfully to constrain the state is to eliminate
from its purview the task of monetary policy.
Writing in 1776, Adam Smith noted the following regard-
ing public debt:
When national debts have once been accumu-
lated to a certain degree, there is scarce, I
believe, a single instance of their having been
fairly and completely paid. …publick bank-
ruptcy has been disguised under the appear-
ance of a pretend payment. …When it
becomes necessary for a state to declare itself
bankrupt, in the same manner as when it
becomes necessary for an individual to do so, a
fair, open, and avowed bankruptcy is always the
measure which is both least dishonorable to
the debtor, and least hurtful to the creditor.
The honour of a state is surely very poorly pro-
vided for, when in order to cover the disgrace
of real bankruptcy, it has recourse to a juggling
trick of this kind …Almost all states, however,
ancient as well as modern, when reduced to
this necessity, have upon some occasions,
played this very juggling trick (Smith, 1776, pp.
929–930).
The implications of Smith’s logic regarding public debt
have come to fruition as evidenced by the violent situa-
tion in the streets of Athens, the situation facing the
PIIGS (Portugal, Italy, Ireland, Greece and Spain) and the
pending fiscal crisis facing US states such as California,
Illinois and New Jersey. In each of these instances, the
current predicament did not arise over the past year or
two, but rather was the result of decades of public pol-
icy decisions resulting in fiscal imbalance. While pretend
payments and the juggling of finances were able to hide
Global Policy Volume 2 . Issue 2 . May 2011
ª2011 London School of Economics and Political Science and John Wiley & Sons Ltd. Global Policy (2011) 2:2 doi: 10.1111/j.1758-5899.2011.00088.x
Research Article (special section)
184
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