With both inflation and our National Debt stealing headlines over the past year, the concept of deliberately inflating our way out of debt has been reintroduced into mainstream conversation. The term "inflating out of debt" refers to a situation where a government or an economy deliberately pursues a policy of generating inflation as a means to reduce the burden of its debt. In this scenario, the government uses inflation as a tool to decrease the real value of its outstanding debt over time. Of course, inflation also decreases the buying power of currencies and savings.
Here's a simple explanation of how it works:
- When a government or an entity has a significant amount of debt, it means they owe a substantial sum of money to lenders or bondholders. The repayment of this debt, along with the interest payments, can create a significant financial burden.
- Inflation is the general increase in prices of goods and services in an economy over time. When inflation occurs, the purchasing power of a currency decreases, meaning that each unit of currency can buy fewer goods or services.
- If a government wants to reduce the real value of its debt, it may intentionally create inflation by adopting expansionary monetary policies. These policies could involve increasing the money supply, lowering interest rates, or engaging in quantitative easing (buying government bonds or other assets from the market).
- As inflation rises, the nominal value of the outstanding debt remains the same, but the real value of the debt decreases. This is because the debt's value is eroded by the decrease in the purchasing power of the currency. Inflation effectively reduces the burden of debt relative to the economy's overall size.
- In an inflationary environment, governments may find it easier to repay their debt obligations. Since the value of money is decreasing, they can effectively repay their debt using currency that is worth less than when the debt was initially incurred.
It's important to note that "inflating out of debt" can have both positive and negative consequences. On the positive side, it can provide temporary relief to governments struggling with high debt burdens. However, it also carries risks, such as the potential for hyperinflation or loss of confidence in the currency if inflation becomes excessive. There is no evidence that this strategy is being employed by the U.S. government. The Federal Reserve has stated that its interest rate increases are laser-focused on reducing high inflation in the economy.