David Blanchflower has once again suggested that we would not need to worry about austerity if only we allowed price inflation of 5% for a few years. Let us ignore the moral issues of whether there is an optimal extent to which we can rob people of their savings in the name of economic growth. Let us also ignore the fact the the problems with the lack of economic growth are as much supply side problems as anything else. As I explained onConservativeHome a couple of weeks ago, the professor’s arithmetic does not even add up.
One fifth of government debt is index-linked. Index-linked debt cannot be inflated away. 35% of the government’s debt is made up of Treasury Bills, short-dated debt or ultra short-dated debt. There is little that the government can do to inflate this away. This will have to be refinanced within the next seven years (most of it much sooner) and, as inflation expectations will rise if the central bank pursues an explicitly inflationary policy, the cost of refinancing this debt will increase. Over the next five years, the UK government is also planning to borrow an amount not much less than the existing national debt in nominal terms. None of this can be inflated away: it will all have to be financed in the new environment of higher inflation if the Keynesians have their way. So what is the bottom line?
The only debt that can be inflated away with any significant effect is the existing long-dated or medium-dated conventional government debt that has already been issued. This is the debt which the government has promised to service with fixed (not inflation-linked) interest and capital payments. This is currently 43% of the existing national debt, but it makes up only about 20% of the debt that will exist by the end of the proposed policy of creating inflation. If inflation were 5% for a few years, as suggested by Professor Blanchflower, the real value of this debt might fall by about 2%-5% of the total projected debt in 2016: this is a drop in the ocean. This “gain” could easily be cancelled out by a higher inflation risk premium that would be demanded by investors on newly issued government debt.
Read the full original article on ConservativeHome.