Inflation Won’t Cut The Budget Deficit

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It’s a time honoured escape for governments with large debts. Inflate them away.

Unfortunately, it’s not actually all that easy in the modern world.

At the same time, the consultancy claimed the UK is the least well-placed of seven major developed economies – including the US, Germany, Japan and France – to take advantage of soaring prices because a fifth of all Government debt is inflation-indexed.

With welfare payments also linked to prices, high inflation makes it more difficult to cut the budget deficit.

There’re two different parts to this.

Firstly, people who have lent to the government before have learned a lesson: that it is indeed very tempting for a government to inflate their way out of such debts. So some portion of them invest in inflation protected gilts rather than non-inflation protected ones. This makes inflation not a way of escaping the debts.

The second is that everything else that the government owes in the future is now a great deal more inflation protected than it used to be. It’s not just the welfare payments mentioned there. Pensions have automatic cost of living adjustments: both the State pension and the pensions offered to former state workers.

The net effect of these two (and note that those future pensions and welfare payments are vastly larger than what we commonly call the “national debt”) is that inflation isn’t any longer a get out of jail free card for governments with lots of debt.

It helps, yes, especially if you can keep the interest rate below the inflation rate, but not as much as it used to.

Originally published at Forbes.

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Rhoda Klapp
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Rhoda Klapp

“Inflation will reduce the deficit” doesn’t have to be true. It’s just a convenient excuse for governments which cannot rein in spending (and that is pretty much all of them) to delay fixing anything. After all, somebody else will inherit the problem some day or the whole thing will blow and we can get a clean slate and start again.

Spike
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Spike

If we are going to consider doing it, let’s do it whole-hog: A measure that makes the value of the dollar go to zero immediately. The government, with monumental debt (yes, Rhoda, certainly caused by chronic overspending and by nothing else), reaps in all the wealth expressed in dollars in circulation. Now, the US also has Treasury bonds that adjust for inflation, and on which capital gains are also adjusted for inflation. Let’s say that, in the exact same moment, we repudiate those bonds as well. For absolution of its future obligations (except bureaucrat pensions), the US has now sold… Read more »

tyrfing
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tyrfing

The next dodge the government will have is understating the rate of inflation in its statistics.

This would make inflation protection a lot less meaningful.

I suspect that this may already be happening – price indexes often exclude food, gas/oil and housing because “they are too volatile”. Well, “volatile” means that they go up a lot (and sometimes down, but mostly up).

Spike
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Spike

One piece of Trump’s tax reform last December was changing the IRS’s inflation adjustments to use the “chained” Consumer Price Index. The point was to make the annual adjustments smaller, resulting in an invisible tax increase each year by pushing people into higher tax brackets (though less severely than if there were no adjustment at all). The “core” inflation index is amusing. Apart from letting politicians seize on whichever number proves their point the best (confident that their audience will not look up the truth), it is fantasy to state the inflation rate assuming we neither have to eat nor… Read more »

tyrfing
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tyrfing

The next dodge the government will have is understating the rate of inflation in its statistics.

This would make inflation protection a lot less meaningful.

I suspect that this may already be happening – price indexes often exclude food, gas/oil and housing because “they are too volatile”. Well, “volatile” means that they go up a lot (and sometimes down, but mostly up).