Inflating Away the Public Debt? An Empirical Assessment
69 Pages Posted: 25 Sep 2014
Date Written: July 2014
We propose and implement a method that provides quantitative estimates of the extent to which higher-than-expected inflation can lower the real value of outstanding government debt. Looking forward, we derive a formula for the debt burden that relies on detailed information about debt maturity and claimholders, and that uses option prices to construct risk-adjusted probability distributions for inflation at different horizons. The estimates suggest that it is unlikely that inflation will lower the US fiscal burden significantly, and that the effect of higher inflation is modest for plausible counterfactuals. If instead inflation is combined with financial repression that ex post extends the maturity of the debt, then the reduction in value can be significant.
Keywords: copulas, inflation options, maturity of government debt, required reserves
JEL Classification: E31, E64, G18
Suggested Citation: Suggested Citation