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Printing money to service debt will most likely drive inflation higher, in turn driving up interest rates investors will demand from government bonds. This esc

by mohawk 15y ago

Printing money to service debt will most likely drive inflation higher, in turn driving up interest rates investors will demand from government bonds. This escape route from a towering debt burden was tried by German post-WW1 governments, and lets just say it didn't go very well. It's the reason the Bundesbank is the way it is now.

onemoreact 15y ago
Clearly the interest rate paid relates to past inflation rates, but if the goal is to pay off the national debt not just borrow more a little inflation can help things along. Say inflation is 2% interest rate is 2% over inflation (or 4%) and the bond is for 10 years. 1.04^10/1.02^10 = 1.2143. Now compare that to 3% and major assumption you still need to pay out 2% over inflation well you get 1.212 which is a lower cost. At the same time your debt servicing costs drop. Now it's true that you may need to pay a fraction more than 2% in interest but for small positive increases in inflation it can reduce debt servicing costs significantly. For this to really work well your new debt needs to be well below your debt servicing costs AND you need to hold mostly long term bonds is rarely the case for country’s with debt issues. Unfortunately, few nations are trying to pay off their national debts and are more focused on maximizing their ability to borrow which is another story.
Symmetry 15y ago
I was horribly unclear there. The moderate, potentially politically feasible inflation would have served to overcome nominal price stickiness and helped Greece transition to a slightly lower standard of living gracefully, one they could actually sustain without borrowing based on their production. The unfeasible inflation would just be a backdoor default, and not really any worse than a real default except to the extent that the EU laws prevent Greece from actually defaulting. This would also entail adjustment in living standards. The horrible option that would result in hyperinflation would be continuing to live beyond their means and using inflation to pay off the debts they were continuing to accumulate. I totally agree that that wouldn't end up solving anything.

by mohawk 15y ago

onemoreact 15y ago

Clearly the interest rate paid relates to past inflation rates, but if the goal is to pay off the national debt not just borrow more a little inflation can help things along. Say inflation is 2% interest rate is 2% over inflation (or 4%) and the bond is for 10 years. 1.04^10/1.02^10 = 1.2143. Now compare that to 3% and major assumption you still need to pay out 2% over inflation well you get 1.212 which is a lower cost. At the same time your debt servicing costs drop. Now it's true that you may need to pay a fraction more than 2% in interest but for small positive increases in inflation it can reduce debt servicing costs significantly. For this to really work well your new debt needs to be well below your debt servicing costs AND you need to hold mostly long term bonds is rarely the case for country’s with debt issues. Unfortunately, few nations are trying to pay off their national debts and are more focused on maximizing their ability to borrow which is another story.

Symmetry 15y ago

I was horribly unclear there. The moderate, potentially politically feasible inflation would have served to overcome nominal price stickiness and helped Greece transition to a slightly lower standard of living gracefully, one they could actually sustain without borrowing based on their production. The unfeasible inflation would just be a backdoor default, and not really any worse than a real default except to the extent that the EU laws prevent Greece from actually defaulting. This would also entail adjustment in living standards. The horrible option that would result in hyperinflation would be continuing to live beyond their means and using inflation to pay off the debts they were continuing to accumulate. I totally agree that that wouldn't end up solving anything.