First published: October 2015
Some have invoked inflation as the goddess that would relieve us from the burden of high public debt. We have argued here that although theories exist showing mechanisms according to which public debt was a burden, the empirical evidence were mixed. It is therefore not perfectly clear why one might want to reduce public debt in the current context. Anyway, assume we are willing to reduce public debt.
As argued here, inflation can help the government reduce the real stock of debt. But how much inflation would be necessary today to stabilize or even reduce the total real value of public debt? This article does the simple calculation for the main developed countries.
We know from the same article that the level of inflation that stabilizes the ratio of debt over GDP is
Pi= d/B-g+i
Just for fun, let’s take the data and forecasts from the OECD and compute the required inflation rate necessary to stabilize the debt of GDP ratio in every OECD countries. The projection of g, i, d/B are based on averages over 2002-2016 (14y) or alternatively averages over 2015-2016 (2y). The results are reported in the table below. The data in the first four columns are averages over 2015-2016 except for inflation and computed required inflation for which we report the two values.
Comparing the actual and required inflation rate for the recent period, we conclude that Greece is in a worrying situation followed by Japan and the US who both lack one percentage point of inflation to stabilize debt – although current inflation for the US might be a bad estimate of long-run future inflation. If Japan is on an equilibrium path, I would be curious to know which one… One good news, the EA as a whole could afford deflation up to -1% thanks to their overall public surplus. But that the EA is “a whole” remains to be shown…
| Country | g | B/Y | Surplus/GDP | i | Pi (14 y) | Pi (2 y) | Required Pi (14y) | Required Inflation (2y) |
| France | 1,37 | 122 | -4,03 | 0,6615 | 1,21 | 0,393 | 3,44 | 0,69 |
| Germany | 1,94 | 74 | -1,44 | 0,346 | 1,286 | 0,9955 | 0,93 | -3,81 |
| Greece | 1,21 | 187 | -7,58 | 9,3395 | 1,70 | -0,227 | 9,66 | 7,67 |
| Italy | 1,05 | 158 | -3,23 | 1,5645 | 1,81 | 0,45 | 3,28 | -0,49 |
| Japan | 1,07 | 231 | -6,31 | 0,3565 | -0,50 | 0,6305 | 2,74 | 1,65 |
| UK | 2,35 | 113 | -5,17 | 2,3965 | 2,18 | 0,8115 | 4,59 | 0,77 |
| US | 2,38 | 111 | -6,48 | 2,7645 | 1,80 | 0,945 | 4,98 | 1,92 |
| EA | 1,75 | 109 | -2,95 | 0,9665 | 1,56 | 0,6745 | 2,87 | -0,98 |