Inflation is usually considered to be a bad thing, but some economists have recently suggested that...

Inflation is usually considered to be a bad thing, but some economists have recently suggested that more of it might be good because it would help with the national debt. Can you explain how inflation could make it easier for the government to pay down the national debt?

Expert Solution

Answer: Inflation means a rise in general price level. The inflation causes a reduction in the value of money, or reduces the purchasing power of the monet. As inflation rises, the prices of goods and services rises which means that each dollar available has less purchasing power or can consume less amount of goods and services. This helps the government in two ways:

1. It can impose higher taxes on the public: The government sets the taxes in nominal terms. In order to extract the same value from taxes, it will have to bring in more cash, because cash now has less buying power. This will give the government higher reserves that can pay down the debt.Because of inflation, the government would get more tax revenue as wages and prices increase (e.g. if prices go up 10%, the governments VAT receipts will increase 10%), (if incomes increase 10%, income tax receipts will, roughly, increase 10%. Therefore, inflation helps government automatically get more tax revenue.

2. The second point is that the overall value of debt falls: This is because each dollar is now holds less value, debt loses value. GDP will increase with inflation, so the debt becomes a smaller percentage of that number, and it becomes easier to pay down.

Rahul Sunny answered 3 months ago

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