 From the Ludwig von Mises Institute, this is the Mises Report, a public policy and economic issues commentary series. In this program, we present another part of ten great economic myths. The material heard today was prepared by Murray and Rothbard, Ph.D., of New York Polytechnic Institute for the Mises Institute. Myth number one, deficits are the cause of inflation. Deficits have nothing to do with inflation. In recent decades, we always have had federal deficits. The invariable response of the party out of power, whichever it may be, is to denounce those deficits as being the cause of our chronic inflation. And the invariable response of whatever party is in power has been to claim that deficits have nothing to do with inflation. Both opposing statements are myths. Deficits mean that the federal government is spending more than it is taking in in taxes. These deficits can be financed in two ways. If they're financed by selling treasury bonds to the public, then the deficits are not inflationary. No new money is created. People and institutions simply draw down their bank deposits to pay for the bonds, and the treasury spends that money. Money has simply been transferred from the public to the treasury, and then the money is spent on other members of the public. On the other hand, the deficit may be financed by selling bonds to the banking system. If that occurs, the banks create new money by creating new bank deposits and using them to buy the bonds. The new money in the form of bank deposits is then spent by the treasury, and thereby enters permanently into the spending stream of the economy, raising prices and causing inflation. By a complex process, the Federal Reserve enables the banks to create the new money by generating bank reserves of one-tenth that amount. Thus, if the banks are to buy $100 billion of new bonds to finance the deficit, the Fed buys approximately 10 billion of old treasury bonds. This purchase increases bank reserves by $10 billion, allowing the banks to pyramid the creation of new bank deposits or money by 10 times that amount. In short, the government and the banking system, it controls, in effect, print new money to pay for the federal deficit. Thus, deficits are inflationary to the extent that they are financed by the banking system. They are not inflationary to the extent they are underwritten by the public. Some policymakers point to the 1982-83 period when deficits were accelerating and inflation was abating, as it's statistical proof that deficits and inflation have no relation to each other. This is no proof at all. General price changes are determined by two factors, the supply of and demand for money. During 1982-1983, the Fed created new money at a very high rate, approximately at 15% per annum. Much of this went to finance the expanding deficit. But on the other hand, the severe depression of those two years increased the demand for money. That is, it lowered the desire to spend money on goods in response to the severe business losses. This temporarily compensating increase in the demand for money does not make deficits any the less inflationary. In fact, as recovery proceeds, spending will pick up and the demand for money will fall and the spending of the new money will accelerate inflation. You've been listening to the Mises Report from the Ludwig von Mises Institute. Funds for this series come from the Friends of the Ludwig von Mises Institute, a non-profit educational foundation. Address your comments and inquiries to the Mises Institute, Thatch Hall, Auburn University, Auburn, Alabama, 36849.