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Inflation and Public Debt Reversals in the G7 Countries

  • Bernardin Akitoby
  • Takuji Komatsuzaki
  • Ariel J Binder
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    This paper investigates the impact of low or high inflation on the public debt-to-GDP ratio in the G-7 countries. Our simulations suggest that if inflation were to fall to zero for five years, the average net debt-to-GDP ratio would increase by about 5 percentage points over the next five years. In contrast, raising inflation to 6 percent for the next five years would reduce the average net debt-to-GDP ratio by about 11 percentage points under the full Fisher effect and about 14 percentage points under the partial Fisher effect. Thus higher inflation could help reduce the public debt-to-GDP ratio somewhat in advanced economies. However, it could hardly solve the debt problem on its own and would raise significant challenges and risks. First of all, it may be difficult to create higher inflation, as evidenced by Japan’s experience in the last few decades. In addition, un-anchoring of inflation expectations could increase long-term real interest rates, distort resource allocation, reduce economic growth, and hurt the lower–income households.

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    Paper provided by International Monetary Fund in its series IMF Working Papers with number 14/96.

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    Length: 28
    Date of creation: 10 Jun 2014
    Date of revision:
    Handle: RePEc:imf:imfwpa:14/96
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    1. Aizenman, Joshua & Marion, Nancy, 2009. "Using Inflation to Erode the U.S. Public Debt," Santa Cruz Department of Economics, Working Paper Series qt6xf174rs, Department of Economics, UC Santa Cruz.
    2. Carmen Reinhart & M. Belen Sbrancia, 2015. "The Liquidation of Government Debt," IMF Working Papers 15/7, International Monetary Fund.
    3. S. M. Ali Abbas & Bernardin Akitoby & Jochen R. Andritzky & Helge Berger & Takuji Komatsuzaki & Justin Tyson, 2013. "Dealing with High Debt in an Era of Low Growth," IMF Staff Discussion Notes 13/7, International Monetary Fund.
    4. Darby, Michael R, 1975. "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Inquiry, Western Economic Association International, vol. 13(2), pages 266-76, June.
    5. Krause, Michael U. & Moyen, Stéphane, 2013. "Public debt and changing inflation targets," Discussion Papers 06/2013, Deutsche Bundesbank, Research Centre.
    6. Robert Mundell, 1963. "Inflation and Real Interest," Journal of Political Economy, University of Chicago Press, vol. 71, pages 280.
    7. Cochrane, John H., 2011. "Understanding policy in the great recession: Some unpleasant fiscal arithmetic," European Economic Review, Elsevier, vol. 55(1), pages 2-30, January.
    8. George J. Hall & Thomas J. Sargent, 2010. "Interest rate risk and other determinants of post WWII U.S. government debt/GDP dynamics," Working Papers 01, Brandeis University, Department of Economics and International Businesss School.
    9. Olivier J. Blanchard & Giovanni Dell'Ariccia & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," IMF Staff Position Notes 2010/03, International Monetary Fund.
    10. Martin Feldstein, 1983. "Inflation, Tax Rules, and Capital Formation," NBER Books, National Bureau of Economic Research, Inc, number feld83-1, December.
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