Why Inflation Won't Help to Reduce US Debt

The OMB’s 2011 budget showed that the US debt-to-GDP ratio will continue to rise over next 10 years until 2020, where the projection ends and when US debt will equal 77.2 percent of GDP.

Inflation is one strategy that could be used in an attempt to lessen that debt burden. By putting more dollars into circulation, and lessening the value of each, the feds could try to pay down the same nominal debt that would then be smaller in real, inflation-adjusted terms.  

Unsurprisingly, it is not a practice that pans out well in reality…

“‘Many countries have tried this and they’ve all failed,’ said Mark Zandi, chief economist at Moody’s Economy.com.

“It’s true that inflation could reduce a small portion of U.S. debt. The International Monetary Fund (IMF) estimates that in advanced economies less than a quarter of the anticipated growth in the debt-to-GDP ratio would be reduced by inflation.

“But the mother lode of the country’s looming debt burden would remain and the negative effects of inflation could create a whole new set of problems.”

The new problems that crop up include:

* Inflation-indexed government spending. Many government obligations, like Social Security, are tied to inflation so those costs won’t go down.

* Future debt issuance. Inflation would make it more costly for the US to issue debt in the future because buyers will demand higher interest rates.

* Unintended consequences. Additional costs to society will develop such as increased economic stress for the poor. The poor tend to have salaries that do not increase with inflation. They also tend to require government aid that needs to match the rate of inflation.

For more details visit CNNMoney.com’s coverage of why the US can’t inflate its way out of debt.


Rocky Vega,
The Daily Reckoning