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Could inflation be a good thing for governments in debt?

ADRIAN FLORIDO, HOST:

Here's one fact about inflation - it reduces the real value of debt. So in these times of historic high inflation, our colleagues Adrian Ma and Wailin Wong over at The Indicator From Planet Money wanted to explore if inflation can be a good thing for borrowers, specifically those big borrowers, national governments.

WAILIN WONG, BYLINE: Ricardo Reis is a professor at the London School of Economics.

RICARDO REIS: Imagine that you borrowed $1,000 from a friend of yours 20 years ago. That debt is still $1,000 today. That's how much you promised to pay him or her 20 years later.

ADRIAN MA, BYLINE: Yeah, but the value of a dollar two decades ago is really more like $0.62 in today's money.

REIS: And as a result, those thousand dollars, which were such a big deal back then, now for you are a very small deal.

WONG: So inflation can be good for people with car payments, mortgages, student loans. But can it also be good for some of the biggest borrowers around - national governments? Rising inflation is making it a little easier for governments to pay off the debt that many of them racked up during the pandemic. Ricardo Reis says this may sound good on the surface.

REIS: Yes. However, if it's coming through inflation, there is a difficult trade-off between the present and the future.

MA: That's because folks who lend to the government - you know, the bond holders - they see inflation chipping away at the returns that they should be getting on their government bonds. And they say, well, OK, it's too late for the old bonds, but next time...

REIS: They will start asking for higher and higher interest rates on the U.S. government. As the government pays those higher interest rates, the government finds that today's gains are eaten away by having to pay higher interest rates to compensate investors for their expected loss of value - so no, not a good thing per se.

WONG: OK, so inflation may make old debt easier to pay off, but it also makes new debt more expensive. Bottom line, Ricardo says a country cannot inflate its way out of debt without some pretty serious consequences.

MA: Yeah. An example of this happened in France after World War II. For a few years, it saw annual inflation over 50%, and before long, its war debt had basically melted away. So inflation was great for wiping out its debt, but, you know, it was also a great at wiping out the savings of a lot of everyday people.

WONG: And Ricardo says the inflate-your-debt-away strategy can have even worse consequences. If everyone - investors, businesses, workers - expects higher inflation, that can lead to an inflation spiral.

MA: I don't think I need to say this, but to sum up, trying to inflate away debt is dicey. Also worth mentioning, that strategy hurts the people who could least afford it, like folks whose wealth is mostly in cash in the bank or in their wallet rather than stocks or bonds or real estate.

WONG: So the shrinking of pandemic debt may seem like a silver lining on the cloud of inflation. But if history is any guide, it's not a silver bullet for government debt.

MA: Adrian Ma.

WONG: Wailin Wong, NPR News.

(SOUNDBITE OF ALT-J SONG, "3WW") Transcript provided by NPR, Copyright NPR.

Adrian Ma
Adrian Ma covers work, money and other "business-ish" for NPR's daily economics podcast The Indicator from Planet Money.
Wailin Wong
Wailin Wong is a long-time business and economics journalist who's reported from a Chilean mountaintop, an embalming fluid factory and lots of places in between. She is a host of The Indicator from Planet Money. Previously, she launched and co-hosted two branded podcasts for a software company and covered tech and startups for the Chicago Tribune. Wailin started her career as a correspondent for Dow Jones Newswires in Buenos Aires. In her spare time, she plays violin in one of the oldest community orchestras in the U.S.