A study found that the increase in government expenditure could heighten inflationary pressures and harm the entire public. In particular, in the worst-case scenario, there is concern that the government could face a 'rollover crisis,' where it might be unable to manage the expenditure increase due to inflation, leading to bankruptcy.
Francesco Bianchi, a professor at Johns Hopkins University, presented a paper titled “The Impact of Fiscal Factors on Inflation in OECD Countries” containing this content during the third session of the 'BOK International Conference' at the Bank of Korea's annex conference hall in Jung-gu, Seoul, on the 2nd.
Professor Bianchi analyzed the impact of the expansion of government expenditure on prices from 2020 to 2023, during the spread of COVID-19, from the perspective of the fiscal theory of the price level (FTPL).
The fiscal theory of the price level is a theory that sees inflation as determined by fiscal factors, such as government fiscal deficits, rather than monetary factors like the amount of currency. According to this theory, if inflation occurs and the value of currency falls, the real liability burden decreases, making it possible for the government to tolerate inflation to mitigate the fiscal deficit.
According to Professor Bianchi's analysis, during the pandemic period, over 80% of the increased government expenditure was covered by reducing the real value of liabilities through unexpected inflation, rather than through traditional funding methods like tax increases or future government expenditure cuts.
Based on this, Professor Bianchi concluded that the high inflation phenomenon observed globally after COVID-19 was caused by an increase in government expenditure. He noted, “As a large-scale fiscal policy was pursued at the time, the scope for the Central Bank to intervene diminished, and liabilities rapidly increased, heightening inflationary pressures and concerns over economic recession.”
He continued, “If asked whether this fiscal policy was correct, I think it was a mistake,” diagnosing that “While reliance on fiscal policy was inevitable as monetary policy tools like ultra-low interest rates had already been considerably exhausted, too much money was injected.”
Saki Bigio, a professor at UCLA who attended as a discussant, warned that if government expenditure increases sharply, a situation might arise where even inflation cannot cover the fiscal deficit.
Professor Bigio stated, “(With government expenditure increases) If the value of U.S. government bonds declines, bondholders may react unexpectedly,” adding, “Should bond investors suddenly lose interest in U.S. government bonds, a rollover crisis (a situation where maturing debt cannot be extended) could occur.”
Professor Bianchi also noted, “I believe the likelihood of a rollover crisis has increased compared to a few years ago,” adding, “As there is a possibility that fiscal authorities may increase expenditure more than before, it is important for the Central Bank to maintain its independence.”