Major wars are funded by “substantial inflation,” according to a new study published by the National Bureau of Economic Research. The study was authored by Hugh Rockoff, an economics professor at Rutgers University.
“During wars against minor powers, the [United States federal] government was able to fund the war by borrowing and levying taxes,” Rockoff wrote. “In major wars, however, there came a point when further increases in taxes could not be undertaken for administrative or political reasons, and further increases in borrowing could not be undertaken except at higher interest rates; rates that exceeded what was considered fair based on prewar norms. At those moments governments turned to the printing press. The result was substantial inflation.”
For example, during World War II, federal spending as a percent of gross domestic product rose by 35 percentage points, while revenue rose only 14 percentage points. The rest was filled by either borrowing or printing money. The relatively smaller Korean War increased spending as a portion of GDP by 6 percentage points, while tax revenue rose by 5 points.
Legislators frequently turn to the printing press to finance wartime spending for several reasons. First, tax hikes are not ideal because of potential public opposition, and it also takes time for tax revenue to reach the government’s coffers. Inflationary policies are less noticeable to the public and easier to pass. That makes it easier for legislators to hide the cost of war from the public, whereas tax hikes are typically visible in plain sight.
Rockoff examined 10 U.S. wars, beginning with the Revolutionary War and going through the First Iraq War in the early 1990s.
According to Rockoff, governments have been hesitant to engage in the large scale borrowing required to conduct major wars because it would lead to much higher interest rates, showing the war was undermining the economy.
The methods of war funding changed with the establishment of the Federal Reserve in 1913. “In the Revolution, the War of 1812, and the Civil War the phrase ‘printing money’ was literally true; after 1913 it became a metaphor,” Rockoff wrote.
