Can inflation help countries dial down their debt? : The Indicator from Planet Money We often talk about inflation as a bad thing. But for countries in a lot of debt, inflation has an upside. But can a country try to inflate its way out of debt?

Can inflation ... inflate away debt?

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Hot off the presses - inflation numbers for April are out.


Well, depending on when you listen to this episode, the news may be warm off the presses or even cold off the presses.

MA: Hey, I feel like our show is like cold pizza, right? It's still good the day after.

WONG: Still delicious.

MA: OK. So the news is, last month, inflation was up 8.3% from a year ago. That is according to the Labor Department's Consumer Price Index. And 8.3% is slightly lower than March's figure.

WONG: And yet it's more data showing we're still near the highest levels of inflation in four decades.

MA: So with that in mind, we're going to kick this episode off with an idea that might sound a little controversial, and that is inflation can be good. I know most of the time on the show, we talk about inflation as a bad thing - how it erodes the value of our wages and our savings.

WONG: But, you know, inflation can be good for borrowers, for individuals with outstanding debts. Ricardo Reis is a professor at the London School of Economics, and he explains it like this.

RICARDO REIS: Imagine that you borrowed $1,000 from a friend of yours 20 years ago. That debt is still $1,000 today. That's how much you promised to pay him or her 20 years later.

MA: Yeah, but the value of a dollar two decades ago is really more like $0.62 in today's money.

REIS: And as a result, those thousand dollars, which were such a big deal back then, now, for you, are a very small deal.

WONG: So inflation can be good for people with car payments, mortgages, student loans. But can it also be good for some of the biggest borrowers around - national governments? This is THE INDICATOR FROM PLANET MONEY. I'm Wailin Wong.

MA: And I'm Adrian Ma. A lot of countries, especially the U.S., took on a ton of debt during the pandemic. And for all its downsides, inflation is actually helping to shrink that debt burden. So today on the show, we'll learn how the heck is that possible and whether a country's debt can be inflated away.


MA: If you've ever applied for a loan, you know there are two questions a lender usually wants to know. How much debt are you in, and how much do you make? That's what lenders call your debt-to-income ratio. They want to know, when it comes to making the payments, are you going to be good for it? Well, for the governments of the world, there's a similar metric they get measured by, and that is their debt-to-GDP ratio.

WONG: And it's worth pausing a sec to take that apart. Debt is how much the government owes to the holders of things like government bonds, and GDP is gross domestic product - the value of goods and services produced in a given period. You can think about GDP as the country's income.

MA: And so when you put those two things back together, you get the country's debt-to-GDP ratio. This is a key metric investors use to gauge just how creditworthy a country is. Like, how likely will it be to make good on its debt? And for example, early in the pandemic, the U.S. hit a debt to GDP of 133%. That may sound high, but it is not unique. Around the same time, countries that were in the same ballpark debt-wise included Canada, France, Portugal and Italy.

WONG: One reason this ratio matters is the higher it goes, the more difficult it may become for a government to borrow by issuing bonds. That's 'cause for the government's would-be creditors - think banks, pension funds, retirement funds and the like - a high debt load can signal a risky investment.

MA: Now there are a few ways for a country to lower its debt-to-GDP ratio. Ricardo Reis from the London School of Economics says you could focus on the debt part of the equation.

REIS: Just as with you, if your debt gets too high relative to your income, that means that, in the future, in order to pay back that debt, you have to either spend less or make more in order to pay for it.

WONG: In government speak, there's a term for this that strikes fear in the heart of policymakers. It's called austerity.

REIS: Which is nothing but consume less and therefore have your citizens be impoverished for a while because you're sending very large payments abroad on account of the large debt that you have.

WONG: Wow. Put that on a poster. Hey, citizens, be impoverished for a while.

MA: Oh, yeah. Austerity is basically the macro financial equivalent of cutting up the credit cards and pawning off the furniture. It often means cutting back on services and benefits and increasing taxes or even selling off government assets. An example from recent history - think of the turmoil Greece went through in the wake of the Great Recession.

WONG: Another way for a country to lower its debt-to-GDP ratio is to work on the GDP part of the equation. This can happen in one of two ways. One option, a country can grow its GDP, its national income, by producing more stuff. And actually, the U.S. went through a version of this in the years after the Second World War.

ANDREW BOSSIE: We come out of the war with a debt-to-GDP ratio of about 120%. At the time, that was absolutely unprecedented.

WONG: That's Andy Bossie, econ professor at New Jersey City University.

BOSSIE: And then the end of the '40s is kind of a transition period out of a war economy back into a civilian economy. You have households who are ready to start consuming again, buy cars, buy other consumer durables, you know, buy houses, more planes, more TVs.

MA: And as the civilian economy gained steam, the amount of stuff produced grew and grew, and GDP grew. And by the time we get to 1970, the ratio of debt to GDP shrank from 120% to just 35%.

WONG: Whoa.

MA: Yeah. And it didn't come from austerity. It came from essentially growing prosperity.

WONG: Now, option No. 2 for growing the GDP part of the equation - stuff getting more expensive. In other words - inflation. As we know, this has been happening around the world in recent months, and that rising inflation is making it a little easier for governments to pay off the debt that many of them racked up during the pandemic. Ricardo Reis says this may sound good on the surface.

REIS: Yes. However, if it's coming through inflation, there is a difficult trade-off between the present and the future. This inflation is the gain of the government at the expense of the lender. It is a zero-sum game.

MA: That's because folks who lend to the government - you know, the bondholders - they see inflation chipping away at the returns that they should be getting on their government bonds. And they say, well, OK, it's too late for the old bonds, but next time...

REIS: They will start asking for higher and higher interest rates on the U.S. government. As the government pays those higher interest rates, the government finds that today's gains are eaten away by having to pay higher interest rates to compensate investors for their expected loss of value - so no, not a good thing, per se.

WONG: OK. So inflation may make old debt easier to pay off, but it also makes new debt more expensive. Bottom line, Ricardo says a country cannot inflate its way out of debt without some pretty serious consequences.

MA: Another example from the post-World War II period is France. For a few years, it saw annual inflation over 50%. And before long, its war debt had basically melted away - great for wiping out debt, but also great at wiping out the cash savings of a lot of everyday people.

WONG: And Ricardo says the inflate-your-debt-away strategy can have even worse consequences. If everyone - investors, businesses, workers - expects higher inflation, that can lead to an inflation spiral.

REIS: This is pretty much every hyperinflation the world has experienced in the last 100 years, with only a few exceptions. Almost every hyperinflation was the result of a government having such a large debt that they found themselves unable to collect the taxes to pay for it, resorted to inflation, and that started a spiral that led to the whole value of the debt certainly going to zero with hyperinflation, but also the government being completely unable to borrow at all and, in the process, destroying its economy.

WONG: Now, hyperinflation is really extreme. That's where prices are rising by 50% each month, and the U.S. is far away from that.

MA: I don't think I need to say this, but to sum up, trying to inflate away debt is dicey. Also worth mentioning, that strategy hurts the people who could least afford it - like, folks whose wealth is mostly in cash, in the bank or in their wallet rather than stocks or bonds or real estate.

WONG: So the shrinking of pandemic debt may seem like a silver lining on the cloud of inflation, but if history is any guide, it's not a silver bullet for government debt.


MA: This episode was produced by Nicky Ouellet and Jamila Huxtable with engineering from Isaac Rodrigues. It was fact-checked by Corey Bridges. Viet Le is our senior producer. Kate Concannon edits the show. And THE INDICATOR is a production of NPR.

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