IMF: High inflation boosts public finances

In spite of the deficits of the pandemic, debt as a percentage GDP has fallen in Italy and the US.Higher inflation has bolstered advanced economies’ public finances, the IMF said on Monday, as it called on governments to use the windfall to cut deficits.

The fund published research that showed that debt burdens were significantly reduced by the unexpected rise in prices over the last two years.

The IMF data shows that the US’s net debt burden fell from 99 percent of its gross domestic product in 2020, to 95 percent in 2022. This was despite large budget deficits during the pandemic. Italy’s net debt fell from 142% of GDP to 135 percent.

Paolo Mauro, the deputy director of IMF’s fiscal affairs division, cautioned that governments shouldn’t “count” on public debt levels falling due to so-called “surprise inflation”.

He said that “you cannot keep surprising people” and added that fiscal authorities should reduce budget deficits in order to assist central banks with controlling high price increases.

High inflation resulted in a financial windfall for the public because of the greater than expected price rise in 2021-2022. Many people lost out because they preferred to lend to governments at lower rates of return than higher debt costs, which usually come with higher inflation.

According to the fund’s research, an unexpected inflation rise of 1 percentage point would decrease GDP’s share of public debt by an average of 0.9 percent for countries with debt burdens greater than 50%. The majority of advanced economies have debt burdens that are much higher than this.

Mauro however stated that the inflation benefit to taxpayers at cost to bond holders is unlikely to be repeated.

Bond markets are now pricing the shock to prices caused by supply chain problems during pandemic and an increase in food and energy costs across Europe following Russia’s invasion.

The yields on the benchmark US 10-year government bond are up from 1.1 percent at the beginning of 2021 to 3.5% today. Similar increases have been seen in advanced economies as well as at all maturities.

These estimates were published in an analytic chapter of IMF’s Fiscal Monitor before the spring meetings of the fund next week.

These data also indicated that inflation helped to boost tax revenues, which tends to increase in line with the price of goods and services. The public spending was, however, less sensitive to inflation and took some time to catch up.

Most advanced countries increase their public pensions and social insurance automatically to deal with higher inflation. However, most countries have not changed thresholds in tax systems or indexed public sector wages to inflation. This has led to a reduction in the global government deficits through a disguised rise in taxation.

The poorest and emerging economies had no indexation in either their spending or public taxes. They were less affected by the unexpected bout of inflation due to their dependence on dollar funding.

In recent years, the US currency has seen a sharp rise in value. This has left emerging economies struggling to cover higher debt costs.

Research by the IMF also showed that reducing budget deficits can help to curb price pressures. A reduction of 1 percent of GDP would result in a fall of 0.5 percentage points in inflation. According to the IMF, fiscal policy can “help” central banks lower inflation.

The IMF stated that “well-targeted fiscal restraint could be designed to support monetary policy in attaining price stability and protecting the vulnerable from the costs of living crisis.”


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