Inflation and Public Debt Reversals in Advanced Economies

IMF Working Papers, December 27, 2019

Source details

Scope: Quantitatively assesses effects of inflation shocks on the public debt-to-GDP ratio in 19 advanced economies.
Main quantitative result: A 1 percentage point shock to inflation rate reduces the debt-to-GDP ratio by about 0.5 to 1 percentage points.
Debt maturity effect: The impact is larger and more persistent when the debt maturity is longer, but the difference from the benchmark case is not significant.
Overall implication: Modestly higher inflation, even if accompanied by some financial repression, could reduce public debt burden only marginally in many advanced economies.

Approaches used:
- Simulations based on the debt dynamics equation.
- Estimations of impulse responses by local projections.

Modest inflation episodes are unlikely to produce large reductions in public debt-to-GDP ratios across advanced economies.
Even with accompanying financial repression, debt relief from inflation is likely to be marginal in many advanced economies.
Considerations for policymakers:
- Debt maturity structure matters: longer maturity tends to increase and prolong the debt-reducing effect of inflation, though the difference is not statistically significant relative to the benchmark.
- Reliance on inflation as a debt-reduction tool should be tempered by the limited quantitative effect observed.