There are three ways for governments to shrink their debts: squeezing taxpayers, choosing not to pay, and rolling over borrowing while the economy grows
, a pamphlet published in 1940, John Maynard Keynes looked back on the way that the British government had, in the late 1910s, tried to pay off enormous quantities of debt with a combination of higher taxes and inflation. Wages had not kept up with inflation, meaning “that consumers’ incomes pass[ed] into the hands of the capitalist class”. Meanwhile the rich, as bondholders, had benefited from interest on the loans.
The second option—defaulting or restructuring debts—may be forced on to emerging economies which lack any other way out. If it is, that will cause significant suffering. In advanced economies, though, such things have been increasingly rare since Keynes’s day, and look unlikely to make a comeback. A modern economy integrated into global financial markets has a huge problem if capital markets lock it out as a bad risk.
Even without a mechanism for keeping interest rates low, inflation can go some way to lessening the debt burden. “My gut instinct is that we will need higher inflation to wash away some of the debt,” says Maurice Obstfeld of the University of California, Berkeley . Yet though inflation may be necessary if debt burdens are to shrink, it may not be readily forthcoming.
Well before the pandemic such analysis had led many influential economists to start treating higher public debt as sustainable in a low-inflation, low-interest-rate world. Because the pandemic has pushed both inflation and interest rates the same way—down—their logic still holds. However, there are reasons for scepticism.does not really neutralise public debt. Central banks buy government bonds by creating new money which sits in the banking system in the form of reserves.
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