SYLVIE DOUGLIS, BYLINE: NPR.
(SOUND EXTRACTION OF “WAKING UP TO THE FIRE” BY DROP ELECTRIC)
ADRIEN MA, HOST:
Fresh off the press – inflation figures for April are out.
WAILIN WONG, HOST:
Well, depending on when you tune in to this episode, the news can be hot or even cold.
MA: Hey, I feel like our show is like cold pizza, right? It’s still good the next day.
WONG: Always delicious.
MA: Okay. So the news is that last month inflation was up 8.3% from a year ago. This is according to the Consumer Price Index from the Department of Labor. And 8.3% is slightly lower than the March figure.
WONG: And yet, it’s more data that shows we’re still close to the highest levels of inflation in four decades.
MA: So with that in mind, we’re going to kick off this episode with an idea that may seem a bit controversial, and that is that inflation can be good. I know most of the time on the show we talk about inflation as a bad thing – how it erodes the value of our wages and our savings.
WONG: But, you know, inflation can be good for borrowers, for people with unpaid debts. Ricardo Reis is a professor at the London School of Economics, and he explains it this way.
RICARDO REIS: Imagine borrowing $1,000 from a friend of yours 20 years ago. This debt is still $1,000 today. This is the amount you promised to pay him 20 years later.
MA: Yes, but the value of a dollar twenty years ago was more like $0.62 in today’s currency.
REIS: And therefore those thousands of dollars, which were so big then, are now a very small matter to you.
WONG: So inflation can be good for people who have car payments, mortgages, student loans. But can it also be good for some of the world’s biggest borrowers – national governments? This is THE PLANET MONEY INDICATOR. I am Wailin Wong.
MA: And I’m Adrian Ma. Many countries, especially the United States, have taken on a ton of debt during the pandemic. And for all its downsides, inflation actually helps reduce the debt burden. So today on the show, we’ll learn how the hell is that possible and if a country’s debt can be inflated.
(MUSIC SOUND EXTRACTION)
MA: If you’ve ever applied for a loan, you know there are two questions a lender typically wants to know. How much debt do you have and how much do you earn? This is what lenders call your debt-to-equity ratio. They want to know, when it comes to making the payments, are you going to be good at it? Well, for governments around the world, there’s a similar metric that measures them, and that’s their debt-to-GDP ratio.
WONG: And it’s worth stopping for a second to take that apart. Debt is the amount the government owes holders of government bonds, and GDP is gross domestic product – the value of goods and services produced during a given period. You can think of GDP as the income of the country.
MA: And so when you put those two together, you get the country’s debt-to-GDP ratio. It is a key indicator used by investors to assess the creditworthiness of a country. For example, what will be the probability of repaying his debt? And for example, at the start of the pandemic, the United States reached a debt to GDP ratio of 133%. That may seem high, but it’s not unique. Around the same time, countries that were in the same range in terms of debt included Canada, France, Portugal and Italy.
WONG: One of the reasons why this ratio is important is that the higher it is, the more difficult it can become for a government to borrow by issuing bonds. That’s because to potential government creditors — think banks, pension funds, retirement funds, and the like — high leverage can signal a risky investment.
MA: Now, there are several ways for a country to reduce its debt-to-GDP ratio. Ricardo Reis of the London School of Economics says you could focus on the debt part of the equation.
REIS: Just like you, if your debt gets too high relative to your income, it means that in the future, to pay off that debt, you’ll either have to spend less or earn more to pay it off.
WONG: In government parlance, there’s a term for it that strikes fear into the hearts of policymakers. This is called austerity.
REIS: Which is nothing but consuming less and therefore impoverishing your citizens for a while because you are sending very large payments overseas due to the large debt that you have.
WONG: Wow. Put that on a poster. Hey citizens, be impoverished for a while.
MA: Oh yeah. Austerity is essentially the macro-financial equivalent of cutting up credit cards and pledging furniture. This often means cutting services and benefits and raising taxes or even selling off government assets. An example from recent history – think of the turmoil Greece went through following the Great Recession.
WONG: Another way for a country to reduce its debt-to-GDP ratio is to work on the GDP part of the equation. This can happen in two ways. One option, a country can increase its GDP, its national income, by producing more things. And in fact, the United States had a version of it in the years after World War II.
ANDREW BOSSIE: We’re coming out of the war with a debt-to-GDP ratio of about 120%. At the time, it was absolutely unprecedented.
WONG: It’s Andy Bossie, professor of economics at New Jersey City University.
BOSSIE: And then the late 1940s was kind of a period of transition from a war economy to a civilian economy. You have households that are ready to start consuming again, to buy cars, to buy other consumer durables, you know, to buy houses, more planes, more televisions.
MA: And as the civilian economy grew, the amount of stuff produced grew and grew, and the GDP grew. And by the time we get to 1970, the debt-to-GDP ratio has dropped from 120% to just 35%.
MA: Yeah. And it does not come from austerity. It stemmed essentially from growing prosperity.
WONG: Now option #2 to increase the GDP part of the equation – things get more expensive. In other words – inflation. As we know, this has been happening around the world in recent months, and this rise in inflation is making it a little easier for governments to pay off the debt that many of them have accumulated during the pandemic. Ricardo Reis says it may look good at first glance.
REIS: Yes. However, if it goes through inflation, there is a difficult trade-off between the present and the future. This inflation is the gain of the government at the expense of the lender. It’s a zero-sum game.
MA: It’s because the people who lend to the government – you know, the bondholders – are seeing inflation eat into the returns they should be getting on their government bonds. And they say, well, okay, it’s too late for old bonds, but next time…
REIS: They’re going to start asking higher and higher interest rates from the US government. As the government pays these higher interest rates, the government finds today’s earnings eaten away by having to pay higher interest rates to compensate investors for their lost value expected – so no, that’s not a good thing per se.
WONG: Alright. So inflation can make old debt easier to pay off, but it also makes new debt more expensive. Bottom line, Ricardo says a country can’t inflate its deleveraging without pretty serious consequences.
MA: Another example from the post-World War II period is France. For a few years, it experienced annual inflation above 50%. And in no time, his war debt had all but melted away – great for clearing debt, but also for wiping out the cash savings of many ordinary people.
WONG: And Ricardo says the strategy of inflating your debt can have even worse consequences. If everyone – investors, companies, workers – expects higher inflation, it can lead to an inflationary spiral.
REIS: That’s pretty much every hyperinflation the world has seen in the past 100 years, with a few exceptions. Almost every hyperinflation was the result of a government having such a large debt that it found itself unable to collect the taxes to pay it, resorted to inflation, and that started a spiral that led to the total debt value to zero. with hyperinflation, but also the government being completely unable to borrow at all and in the process destroying its economy.
WONG: Now the hyperinflation is really extreme. This is where prices are increasing by 50% every month, and the United States is nowhere near that.
MA: I don’t think I need to say it, but to sum up, trying to inflate debt is risky. It’s also worth mentioning that this strategy hurts people who could least afford it — like people whose wealth is mostly in cash, in the bank, or in their wallets rather than stocks, bonds, or real estate.
WONG: So pandemic debt reduction may seem like a silver lining on the inflation cloud, but if history is any guide, it’s not a magic bullet for public debt.
(MUSIC SOUND EXTRACTION)
MA: This episode was produced by Nicky Ouellet and Jamila Huxtable with engineering from Isaac Rodrigues. It has been verified by Corey Bridges. Viet Le is our main producer. Kate Concannon edits the show. And THE INDICATOR is an NPR production.
NPR transcripts are created in peak time by an NPR contractor. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative recording of NPR’s programming is the audio recording.