Wednesday, March 16, 2011

Inflation: It's Real Debt Reduction!

If you're in debt, inflation is your friend. While the nominal value of your debt stays the same, its real value decreases, since what you owe is worth less and less. For similar reasons, deflation is your enemy. It makes the real value of your debts increase.

This is one of the many things that I'd like to tell people who are worrying a lot about the national debt. If you think one of the big problems America faces is that we're in trillions of dollars of debt, inflation is your friend! Of course, if bond investors expect higher inflation, they may demand higher interest rates. But if our debt takes a while to roll over, we get the benefits of low interest loans that we can pay back with easy money for that time.

Suppose the Federal Reserve decided to get on board with the inflation-promoting agenda, and let inflation run 4% above where it'd otherwise be. And suppose it took about 5 years for our debt to roll over so that the higher rates of inflation affected the interest rates we were being charged. 1.04^5 = 1.217, so we'd end up with a currency that was 21.7% more inflated and (dividing by that number) 17.8% less real debt. For a debt of $14.2 trillion, that's a $2.5 trillion savings.
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