The Risk of Rising Inflation. By Peter Morgan. Published at Morganist Economics. 14:08 21/09/2021. Copyright © 2021 Peter James Rhys Morgan. Originally published at the link below. https://morganisteconomics.blogspot.com/2021/09/the-risk-of-rising-inflation.html Extremely high government debt creates an additional dimension to economic risk, due to the exposure the public sector debt interest payments have to an increase in inflation or the base rate of interest. Index Linked Gilt return payments move in line with inflation making public sector debt interest payments rise if aggregate prices appreciate. Currently about twenty five percent of the total government debt is Index Linked. This makes government debt incredibly sensitive to a increase in inflation and could cause the debt to spiral massively out of control. Economic techniques can be used to control inflation to prevent this from happening. Usually the base rate of interest rises to decrease aggregate prices, but interest rate increases can be harmful to the economy too. When the base rate of interest is raised the cost of paying debt interest payments increases, which can damage businesses and cause house repossessions. It can also cause the government debt interest payments to rise when new debt is issued, due to the need to compete with the base rate of interest to create demand for treasury debt products. Treasury bills and other short term treasury products are particularly connected to the base rate of interest. According to the UK Debt Management Office (DMO) 'Fiscal Risks Report - July 2021' (pages 172 - 175), government treasury products are extremely closely linked to the base rate of interest. This requires the base rate of interest to remain low to prevent public sector debt return payments from rocketing. Government debt of around one hundred percent of GDP necessitates inflation and the base rate of interest to remain low to avert catastrophe. Elevated levels of inflation and high base rates of interest have been avoided over the past ten to fifteen years, through the utilisation of pension economic control. Instead of the base rate of interest rising to reduce inflation pension saving has been increased to keep inflation low, which has prevented the cost of government debt return payments from soaring. Although the increase in pension saving carries the cost of pension tax relief it is less expensive than higher inflation or base rates of interest, due to the greater public debt return payments they produce. Pension economic control has proven effective at sustaining low levels of inflation without the need to increase the interest rate over the past decade. The cost efficiencies of pension economic control from sustaining low levels of inflation and base rates of interest have been gargantuan. Currently the taxation exempt annual pension saving allowance or the lifetime pension saving allowance are altered to control inflation and attain other economic targets, which only enables pension economic control on an annual basis rather than a monthly basis. Advancements in macroeconomic tools could allow pension economic control on a monthly basis improving the effectiveness of the management of inflation and the base rate of interest. Superior macroeconomic control can prevent government debt return payments from growing in addition to optimising the pension saving process. The development of a completely new pension economic control model and pension economic control organisation the 'Pensionium', could reduce the risk of high inflation and an interest rate rise in addition to optimising costs.
All they have to do is increase pension saving then inflation and the interest rate stay low. Even with the pension tax relief it is cheaper to increase pension saving than having higher inflation or higher interest rates because they cause the cost of government debt returns to rise. Plus you can increase pension saving without the tax relief, just make it so employers have to pay a $1 a month pension contribution that does not receive tax relief. This worked in the UK over the past decade see the link below. https://morganisteconomics.blogspot.com/p/success.html
Spurring inflation is tougher than dampening due to this asymmetry increased government spending carries less risk than refusing to smooth economic shocks which would have much more detrimental impact on economic activity. It's all about this simple tradeoff
The cost of higher inflation is staggering in the United Kingdom because 25% of the 100% of GDP government debt is linked to inflation. If it is not controlled then it will cost the government billions of pounds more every year in government debt interest payments. There is a strong argument from the research I have conducted that inflation is caused by a lack of pension saving. Controlling inflation through increasing pension saving may in itself correct market abnormalities by increasing future provisions for consumption, which will provide a continual level of spending the future from pension annuity income.
Your analysis is probably faulty, as it seems you have failed to take into account the affect of inflation on real rates. It seems you haven't considered that whereas deficits have a one to one, pound for pound, direct link to government issued "debt", inflation is usually only weakly proportional to deficits, if at all. Furthermore, inflation is inversely related to Real Rates. Inflation causes both real rates and the purchasing power of a unit of money to drop. This is why we speak of government inflating debt away, i.e., "monetizing the debt."
No government debt is directly linked to the rate of inflation through Index Linked Gilts, in the United Kingdom 25% of the government debt is linked to inflation. So if inflation increases the government debt interest costs increase by billions of pounds each year. The same is true for America but only 7.5% of the government debt is Index Linked, so it is not as sensitive to an increase in inflation. It does however still cost the USA government £6,056,250,000.00 a month extra in interest payments with the rate of inflation at 5.4%. The annual cost is $72.675 billion from additional inflation of 3.4% above the 2% target.
That's precisely what I said, and you could have left off "through index Linked Gilts" and be just as correct!. We agree totally on this! And now having more carefully read what you wrote, which was "linked", and not "due to", as I incorrectly read, I see that you computed what percent of face value government issued debt was inflation indexed. I see now where your 25% figure comes from. And yes, nominal costs of servicing inflation indexed debt does increase, but do real costs increase? The government is paying the nominal debt servicing increase with deflated pounds. The "real" cost increase is a much harder calculation to do accurately. A correct analysis shows that the government has no real debt in the conventional sense, and the additional money paid in deflated pounds only has meaning in terms of it's inflation adjusted affect on expansion of base money in the economy relative to productivity and demand supply issues. It isn't that the government will run out of money!; as you personally might if you were suddenly confronted with an increase in nominal pounds needed to service your personal debt. You'd be fine if your income kept up with inflation, but what if it didn't! Once again. we see what seems to be an invariant rule, ceteris paribus "inflation is generally good for debtors but bad for creditors." In the case of UK Gilts, the government is the "debtor". In an ideal world the "real" cost of servicing inflation indexed government debt would not change with inflation, but things are seldom ideal. The idea behind inflation indexed Gilts is that the debtor will be spared the harm from "the invariant rule." To what extent that holds in practice is another matter.