Arnold Kling  

Debt Rollover and Inflation

NY Times' Non-Reporting Report... Book 1 and Book 2 Watch...

Megan McArdle and Russ Roberts discuss the issue in the last quarter of their podcast. If you prefer an academic paper, read Joshua Aizenman and Nancy Marion. They write, in part

today's temptation to inflate away some of the debt burden is similar in some respects to that in 1945, when inflation successfully eroded a substantial part of the debt burden Yet there are important differences -shorter debt maturities today reduce the temptation to inflate, while the larger share held by foreign creditors increases it.

The thing is, you can inflate away some of the current debt, but the future obligations for Medicare and so forth would not be reduced by inflation.

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CATEGORIES: Fiscal Policy

COMMENTS (5 to date)
E. Barandiaran writes:

The service of a huge debt poses two problems. A stock problem related to the debt accumulated to finance past deficits. And a flow problem related to future deficits. The question is whether you can solve the stock problem without solving first the flow problem. If you don't do it and solve first the stock problem, the cost of financing future deficits may increase sharply. This is true for private debtors but it's not clear that it applies to governments, especially in democracies.

In relation to the possibility of inflating the stock away, there is an important difference with the 1940s. Today the demand for currency is much lower and the inflation rate that you may need to do inflate the debt way may be much higher than in the 1940s.

Milton Recht writes:

There is more international trade today than in the late 1940s, a free floating exchange rate and more concern about currency valuations.

Similarly, there is a possibility that inflation as a means to lower our debt will push out the US dollar as international reserve currency and as the primary means for international payment.

If another currency becomes the standard international currency, inflation will not work to decrease our debt, the US might be forced to issue non-dollar denominated debt and the likelihood of a US default on its debt will increase.

Boonton writes:

I recall when interest rates fell during Clinton's era, Disney took advantage of it by issueing 50 year bonds (or were they 100 year bonds?). I'm kind of curious why the low rates and what appears to be a liquidity trap aren't today being meet with more governments like the US, UK and Europe rolling their debt over into 50 or 100 year bonds. Granted the market for these will not be as big as 30 year bonds, probably, but still it almost certainly exists.

Niccolo writes:

Russ Roberts is correct about people under 40 not expecting a penny back - coming from someone who is 19.

If I was actually budgeting my life, I would choose a system that factored out social security and medicare for me for accuracy. Not only because I won't be receiving any social security, but because, given my major and anticipated lifespan as an early and heavy smoker, the likelihood is that I will overpay into the system even I expected to get anything back from it at all.

mineralstoffe writes:

The fundamental obstacle to governments eroding their debt through inflation is the duration of the government debt portfolio. If all outstanding debt had ten years before it matured, then governments could inflate their way out of the debt burden. Inflation would ravage bond holders, and governments could create inflation with impunity, secure in the knowledge that existing bond holders could do nothing to punish them.

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