Inflating Away the Debt?

Sorry Arnold we know the costs of becoming a "serial defaulter". Just look at what happened in Argentina since 1951.
The distinction between the "stock" problem (the accumulated debt) and the "flow" problem (the expected deficits over many years) has been known for years. Some economists have yet to learn that it doesn't make much sense to solve the "stock" problem without solving first the "flow" problem.

Would it really be a bad thing if investors becomes less willing to finance the government?

Your point #2 is the same as "Shorter maturities reduce the temptation to inflate."

It gets even worse, than that. Employer health care mandates, act like minimum wages on employment, only unlike minimum wages they can't be inflated away.

On the bright side, US debt becoming worthless would force a solution to the Social Security problem...

#2: The typical consequence is loss of credit rating and high inflation.

Check out Israel's history with its Lira.

Kiff, I think you mean Italy. I believe they still hadn't solved their "flow" problem. Mike's point is that perhaps dynamiting your ability to solve the stock problem, makes you more likely to solve the flow problem. Argentina and Italy do seem suggest perhaps not so much. Lenders seem peculiarly willing to do business with highly uncreditworthy countries.

Social Security benefits are indexed to wages, not prices, so we could bring them under control by destroying the economy.

The answer to question 2 is, regime uncertainty, but that could be a positive. If the old regime is destroyed by its financial mismanagement, then no one will lend to it. But if the destroyed regime is replaced by a new regime with new and sound economic principles, and which holds true to those principles for a significant period of time, then it should be able to borrow. Unfortunately, the process may be cyclical. Power corrupts.

Alex J.,
To some extent you're right about the willingness of some lenders to deal with Argentina. You should know, however, that part of foreing lending was from official sources and another part from Argentinian sources (the recycling of domestic funds).
More important, the cost of a "serial defaulter" is not limited to borrowing (as Arnold seems to imply). In Argentina, I believe that during the past 60 years the investment/GDP ratio has been less than half of what could have been with Canada's fiscal policy (just look at what happened for a few years in the 1990s when foreigners and even some Argentinians believed that fiscal policy had changed).

In response to the above, why are the only options to have very low inflation and not inflate away any of our future debt obligations, or to default? Why can't we take a middling course of inflating away 3% of debt each year, which will make the debt a bit easier to stabilize?

So, there's a raging debate over at "Economists for Firing Larry Summers" about whether the Fed's Monetary Policy is too tight right now. I'm trying to flush out what the Fed's thinking is in not doing more QE, and so I'm basically trying to find someone to defend the Fed and the status quo -- and so am trying to find what conservative economists think. (My apologies if you guys have posted on this already -- I couldn't find anything recent on your blog that was straight to the point...) I'm of the opinion that Fed policy has been habitually too tight since spring of 08, except for the three months after Lehman, and that reappointing Ben Bernanke was a huge mistake. I'd like to hear why I'm wrong.

best, -Thor

http://firelarrysummersnow.blogspot.com/

@Dan Weber:
Amusing, of course, destroying the economy, would make it impossible to pay them as well.
Its a lose, lose situation, as guaranteed benefits pension schemes usually are for the employer.

Some or all of the reason that lenders have continued to finance serial defaulters is that they believe they have a good credit to bail them out when things go bad. Recall the bailout of lenders to Mexico or the recent generalized bailout of too-big-to-fail. This dynamic would change if the bailout authority became itself a serial defaulter. The appetite to lend to obviously bad credit sovereigns is a result of state policy, not markets.

WWII was different because it was perceived--correctly it turns out--as a one time shot. Even if we had inflated WWII debt completely away, in retrospect it still would have been perceived as a an acceptable permanent reduction in (baseline) wealth. The reason is the alternative was seen as worse.

The current situation is the antithesis of a one time shot. It is the opposite, it is likely to be geometrically worse than we think.

I have believed for some time now that WWII is a good model to get us out of this mess (no, not the war part).

I think we need to completely eliminate Social Security and Medicare. Yet we also cannot break social contracts (do people believe in social contracts anymore?). Without getting into fairness minutiae, (legislation would have to), the idea is tell all below a certain age they get will get no SS or Medicare. This would be replaced by either lower tax rates or simply larger 401K and HSA style deductions.

Above some graduated age, the "social contract" exists. Those below that certain age do get stuck with the actuarial bill---which is financed with government borrowing. But we do not become poorer by doing this. We become wealthier because the bleeding stops. We also take our head out of the sand. However, we will feel poorer. But that's because we refuse to face the truth of the non-sustainability of our current system.

This is similar to WWII. Known amount of debt; less wealthy than we thought; but better off than we would have been.

Admittedly, there is an "if pigs had wings they could fly" dreaminess to the above kind of thought. But mankind has overcome far worse things. Perhaps we need to feel the pain before we cure the disease.