IDEAS home Printed from https://ideas.repec.org/p/nbr/nberwo/20339.html
   My bibliography  Save this paper

Inflating Away the Public Debt? An Empirical Assessment

Author

Listed:
  • Jens Hilscher
  • Alon Raviv
  • Ricardo Reis

Abstract

We propose and implement a method that provides quantitative estimates of the extent to which higher- than-expected inflation can lower the real value of outstanding government debt. Looking forward, we derive a formula for the debt burden that relies on detailed information about debt maturity and claimholders, and that uses option prices to construct risk-adjusted probability distributions for inflation at different horizons. The estimates suggest that it is unlikely that inflation will lower the US fiscal burden significantly, and that the effect of higher inflation is modest for plausible counterfactuals. If instead inflation is combined with financial repression that ex post extends the maturity of the debt, then the reduction in value can be significant.

Suggested Citation

  • Jens Hilscher & Alon Raviv & Ricardo Reis, 2014. "Inflating Away the Public Debt? An Empirical Assessment," NBER Working Papers 20339, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:20339
    Note: AP EFG ME
    as

    Download full text from publisher

    File URL: http://www.nber.org/papers/w20339.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Elisa Faraglia & Albert Marcet & Rigas Oikonomou & Andrew Scott, 2013. "The Impact of Debt Levels and Debt Maturity on Inflation," Economic Journal, Royal Economic Society, vol. 0, pages 164-192, February.
    2. Francesco Bianchi & Leonardo Melosi, 2017. "Escaping the Great Recession," American Economic Review, American Economic Association, vol. 107(4), pages 1030-1058, April.
    3. Dimitri Vayanos & Jean‐Luc Vila, 2021. "A Preferred‐Habitat Model of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 89(1), pages 77-112, January.
    4. Kitsul, Yuriy & Wright, Jonathan H., 2013. "The economics of options-implied inflation probability density functions," Journal of Financial Economics, Elsevier, vol. 110(3), pages 696-711.
    5. Ait-Sahalia, Yacine & Lo, Andrew W., 2000. "Nonparametric risk management and implied risk aversion," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 9-51.
    6. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-179, March.
    7. Carmen M. Reinhart & Kenneth S. Rogoff, 2014. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," Annals of Economics and Finance, Society for AEF, vol. 15(2), pages 215-268, November.
    8. George J. Hall & Thomas J. Sargent, 2011. "Interest Rate Risk and Other Determinants of Post-WWII US Government Debt/GDP Dynamics," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(3), pages 192-214, July.
    9. Carmen M. Reinhart & Vincent R. Reinhart & Kenneth S. Rogoff, 2012. "Public Debt Overhangs: Advanced-Economy Episodes since 1800," Journal of Economic Perspectives, American Economic Association, vol. 26(3), pages 69-86, Summer.
    10. Davig, Troy & Leeper, Eric M. & Walker, Todd B., 2011. "Inflation and the fiscal limit," European Economic Review, Elsevier, vol. 55(1), pages 31-47, January.
    11. Reinhart, Carmen & Rogoff, Kenneth, 2009. "This Time It’s Different: Eight Centuries of Financial Folly-Preface," MPRA Paper 17451, University Library of Munich, Germany.
    12. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates," Introductory Chapters, in: This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press.
    13. Matthias Doepke & Martin Schneider, 2006. "Inflation and the Redistribution of Nominal Wealth," Journal of Political Economy, University of Chicago Press, vol. 114(6), pages 1069-1097, December.
    14. Woodford, Michael, 2010. "Optimal Monetary Stabilization Policy," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 14, pages 723-828, Elsevier.
    15. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," The Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
    16. Reinhart, Carmen & Rogoff, Kenneth, 2009. "This Time It’s Different: Eight Centuries of Financial Folly-Chapter 1," MPRA Paper 17452, University Library of Munich, Germany.
    17. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. "Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-1632, December.
    18. Bhupinder Bahra, 1997. "Implied risk-neutral probability density functions from option prices: theory and application," Bank of England working papers 66, Bank of England.
    19. Del Negro, Marco & Sims, Christopher A., 2015. "When does a central bank׳s balance sheet require fiscal support?," Journal of Monetary Economics, Elsevier, vol. 73(C), pages 1-19.
    20. Antje Berndt & Hanno Lustig & Şevin Yeltekin, 2012. "How Does the US Government Finance Fiscal Shocks?," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(1), pages 69-104, January.
    21. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, vol. 7(2), pages 151-174.
    22. Mark Aguiar & Manuel Amador & Emmanuel Farhi & Gita Gopinath, 2013. "Crisis and Commitment: Inflation Credibility and the Vulnerability to Sovereign Debt Crises," Working Papers 2013-4, Princeton University. Economics Department..
    23. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-651, October.
    24. Carmen M. Reinhart & M. Belen Sbrancia1, 2015. "The liquidation of government debt," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 30(82), pages 291-333.
    25. Davide Debortoli & Ricardo Nunes & Pierre Yared, 2017. "Optimal Time-Consistent Government Debt Maturity," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 132(1), pages 55-102.
    26. Henning Bohn, 2011. "The Economic Consequences of Rising U.S. Government Debt: Privileges at Risk," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 67(3), pages 282-302, September.
    27. Hess Chung & Eric M. Leeper, 2007. "What Has Financed Government Debt?," NBER Working Papers 13425, National Bureau of Economic Research, Inc.
    28. Michael U. Krause & Stéphane Moyen, 2016. "Public Debt and Changing Inflation Targets," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(4), pages 142-176, October.
    29. Refet S. Gürkaynak & Brian Sack & Jonathan H. Wright, 2010. "The TIPS Yield Curve and Inflation Compensation," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(1), pages 70-92, January.
    30. Aizenman, Joshua & Marion, Nancy, 2011. "Using inflation to erode the US public debt," Journal of Macroeconomics, Elsevier, vol. 33(4), pages 524-541.
    31. Christopher A. Sims, 1982. "Policy Analysis with Econometric Models," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 13(1), pages 107-164.
    32. 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.
    33. Mats Persson & Torsten Persson & Lars E. O. Svensson, 2006. "Time Consistency of Fiscal and Monetary Policy: A Solution," Econometrica, Econometric Society, vol. 74(1), pages 193-212, January.
    34. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
    35. Missale, Alessandro & Blanchard, Olivier Jean, 1994. "The Debt Burden and Debt Maturity," American Economic Review, American Economic Association, vol. 84(1), pages 309-319, March.
    36. Refet S. Gürkaynak & Brian Sack & Eric Swanson, 2005. "The Sensitivity of Long-Term Interest Rates to Economic News: Evidence and Implications for Macroeconomic Models," American Economic Review, American Economic Association, vol. 95(1), pages 425-436, March.
    37. Campa, Jose M. & Chang, P. H. Kevin & Reider, Robert L., 1998. "Implied exchange rate distributions: evidence from OTC option markets1," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 117-160, February.
    38. Fisher, Lawrence & Weil, Roman L, 1971. "Coping with the Risk of Interest-Rate Fluctuations: Returns to Bondholders from Naive and Optimal Strategies," The Journal of Business, University of Chicago Press, vol. 44(4), pages 408-431, October.
    39. Benjamin M. Friedman & Michael Woodford (ed.), 2010. "Handbook of Monetary Economics," Handbook of Monetary Economics, Elsevier, edition 1, volume 3, number 3.
    40. Eric M. Leeper & Xuan Zhou, 2013. "Inflation's Role in Optimal Monetary-Fiscal Policy," NBER Working Papers 19686, National Bureau of Economic Research, Inc.
    41. Olivier Blanchard & Giovanni Dell'Ariccia & Paolo Mauro, 2010. "Rethinking Macroeconomic Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(s1), pages 199-215, September.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Leeper, E.M. & Leith, C., 2016. "Understanding Inflation as a Joint Monetary–Fiscal Phenomenon," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 2305-2415, Elsevier.
    2. Reinhart, Carmen M. & Reinhart, Vincent & Rogoff, Kenneth, 2015. "Dealing with debt," Journal of International Economics, Elsevier, vol. 96(S1), pages 43-55.
    3. Carmen M. Reinhart & Franziska L. Ohnsorge & Kenneth S. Rogoff & M. Ayhan Kose, 2022. "The Aftermath of Debt Surges," Annual Review of Economics, Annual Reviews, vol. 14(1), pages 637-663, August.
    4. Equiza-Goñi, Juan, 2016. "Government debt maturity and debt dynamics in euro area countries," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 292-311.
    5. Limodio,Nicola & Strobbe,Francesco, 2016. "Financial regulation and government revenue : the effects of a policy change in Ethiopia," Policy Research Working Paper Series 7733, The World Bank.
    6. Bernardin Akitoby & Ariel Binder & Takuji Komatsuzaki, 2017. "Inflation and Public Debt Reversals in the G7 Countries," Journal of Banking and Financial Economics, University of Warsaw, Faculty of Management, vol. 1(7), pages 5-27, May.
    7. Juan Equiza Goni, 2014. "Sovereign Debt Maturity and Debt-to GDP Dynamics in Six Euro Area Countries," Working Papers ECARES ECARES 2014-44, ULB -- Universite Libre de Bruxelles.
    8. Howard Kung & Gonzalo Morales & Alexandre Corhay, 2017. "Fiscal Discount Rates and Debt Maturity," 2017 Meeting Papers 840, Society for Economic Dynamics.
    9. Nicola Limodio, 2015. "The Development Impact of Financial Regulation: Evidence from Ethiopia and Antebellum USA," 2015 Meeting Papers 355, Society for Economic Dynamics.
    10. Sewon Hur & Illenin O. Kondo & Fabrizio Perri, 2018. "Real Interest Rates, Inflation, and Default," Staff Report 574, Federal Reserve Bank of Minneapolis.
    11. Tyler Muir, 2017. "Financial Crises and Risk Premia," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 132(2), pages 765-809.
    12. Carmen M. Reinhart & Miguel Angel Santos, 2016. "From Financial Repression to External Distress: The Case of Venezuela," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 52(2), pages 255-284, February.
    13. Claudio Borio, 2011. "Rediscovering the Macroeconomic Roots of Financial Stability Policy: Journey, Challenges, and a Way Forward," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 87-117, December.
    14. Yutaka KURIHARA, 2015. "Debt and Economic Growth: The Case of Japan," Journal of Economics Library, KSP Journals, vol. 2(2), pages 45-52, June.
    15. Lorenzo Esposito & Giuseppe Mastromatteo, 2019. "Defaultnomics: Making Sense of the Barro-Ricardo Equivalence in a Financialized World," Economics Working Paper Archive wp_933, Levy Economics Institute.
    16. Panizza, Ugo & Presbitero, Andrea F., 2014. "Public debt and economic growth: Is there a causal effect?," Journal of Macroeconomics, Elsevier, vol. 41(C), pages 21-41.
    17. Can Gao & Ian W. R. Martin, 2021. "Volatility, Valuation Ratios, and Bubbles: An Empirical Measure of Market Sentiment," Journal of Finance, American Finance Association, vol. 76(6), pages 3211-3254, December.
    18. Ichiro Fukunaga & Takuji Komatsuzaki & Hideaki Matsuoka, 2022. "Inflation and public debt reversals in advanced economies," Contemporary Economic Policy, Western Economic Association International, vol. 40(1), pages 124-137, January.
    19. Panizza, Ugo & Fatás, Antonio & Ghosh, Atish R. & ,, 2019. "The Motives to Borrow," CEPR Discussion Papers 13735, C.E.P.R. Discussion Papers.
    20. Michael U. Krause & Stéphane Moyen, 2016. "Public Debt and Changing Inflation Targets," American Economic Journal: Macroeconomics, American Economic Association, vol. 8(4), pages 142-176, October.

    More about this item

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E64 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Incomes Policy; Price Policy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:20339. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/nberrus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.