Budget deficits, government spending, and inflation risks

Macroeconomic Situation

Issues related to a massive budget deficit have resulted from printing large sums of money to support the stimulus package for economic recovery. This year's budget deficit is expected to total a record $1.84 trillion -- fueled by the banking bailout to stabilize the financial system and the fiscal stimulus package to jump-start the economy (Lazarro, 2009). According to Lazarro, the administration forecasts a $1.26 trillion for fiscal year 2010, nearly triple fiscal year 2008 when the government posted a then-record $454.8 billion deficit. Many believe that, as a result of the huge government spending, the United States will eventually experience inflation or perhaps even hyperinflation and also fear that the government won't be able to rein it in.

Interest rates will increase as foreign United States dollar debt holders lose confidence and the dollar falls (Fleckenstein, 2009). Thus, Fleckenstein asserts that government debt payments will increase and force the United States government to continue monetizing the debt at a time when it should be tightening spending. A vicious cycle of higher and higher inflation rates and a weaker and weaker dollar will follow amid economic weakness because personal incomes will be squeezed by inflation. Typical monetary policy to control inflation will be difficult for two reasons according to Fleckenstein. First, because the economy recovery is likely to be very fragile, the government will be reluctant to increase interest rates in the short run. Further, given the size of the government deficit, the government will also not want to increase interest rates because it would increase the interest burden.