Because the national debt keeps getting bigger, some pundits have speculated that, instead of raising taxes, the United States could simply print more money to pay it down.
In this scenario, the Federal Reserve, which controls the nation’s money supply, would print new dollars and use them to buy any new bonds issued by the federal government. It wouldn’t be historically unprecedented. In fact, it’s been done many times in the past.
But nothing comes free, and though printing more money would avoid higher taxes, it would also create a problem of its own: inflation.
Inflation is a general increase in the prices of goods and services throughout an economy. When there’s an increase in the money supply without a corresponding increase in economic activity, there’s also a decrease in the purchasing power of each individual dollar. Each dollar buys less because there are so many more dollars circulating in the economy.
Here’s a basic example: In 1913, a gallon of milk cost about 36 cents. In 2013, it cost $3.53. It’s not because it’s any more difficult to produce a gallon of milk today than it was 100 years ago. It’s because the money supply is much larger now, so people demand more dollars for the same products to keep up with the general rise in prices.
A little bit of inflation is normal and manageable. In a growing economy, you want moderate growth in the money supply so people have enough cash to buy and sell all the new goods and services being produced. But high inflation can throw an economy into havoc. Borrowers benefit because it means they can repay their debts with less valuable money. Creditors, on the other hand, are worse off because it means they're repaid with less valuable dollars.
In short, we will have to pay our national debt at some point. Either it’ll be through higher taxes levied by the federal government or through higher prices in the economy at large.
Want to see how much buying power today’s dollar has relative to ten years ago? Check out the Bureau of Labor Statistics’s inflation calculator here.