Beyond the Headlines | 12 Apr 2024

How Inflation eroded governments’ debts and why it matters | Beyond the Headlines

Gabriel Sterne

Head of Global Emerging Markets

Our latest video for asset managers

The supply-shocks era (2020-23) represented the first time in a generation where inflation significantly eroded the real value of global public debt.

In this week’s video, Gabriel Sterne, Head of Global Emerging Markets, focuses on the extent to which governments seized that opportunity.

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I’m Gabriel Sterne, Head of Global Emerging markets at Oxford Economics

Question: During your entire career, what is the comment you have heard most at economics events you have attended?

For me, no question…its “Governments will eventually inflate away their debt”

Today Im going to speak about that with reference to my recently published research “How inflation eroded governments’ debts and why it matters”

My narrow focus is on extent to which governments seized that opportunity in the supply shocks era (2020-23).

After all, there was rampant inflation and you couldn’t really blame most governments for it… Surely this was the moment for inflation erosion opportunists.

But the anatomy of what actually happened may surprise you.

In the average Emerging Market, inflation erosion 3.7% of GDP over the whole period; for the average for advanced economy it was actually twice that.

Its that way simply because AEs have much bigger piles of debt

That’s how the inflation tax works, its impact on debt is the fall in real effective interest rates multiplied by the initial debt stock

For both EMs and AEs the decline in the real effective interest rate was about the same, 2.5% lower in 2020-23 relative to 2019

Why does it matter?

The period turned preconceptions upside down regarding the location of safe havens for global bonds; EM policymakers got ahead of the curve and enhanced credibility relative to advanced economies.
- Average returns for safe havens Switzerland, US and Japan were -13%; in contrast the four riskier sovereigns (Mexico, Brazil, South Africa and Colombia) it was +11%.

The period offers little support for those predicting that one day governments will inflate away their debt problems.
- Inflation erosion of debt has been associated with very high economic costs,
- Oh, and government debt-to-GDP ratios did actually increase overall, lest we forget.
- Its certainly not a good advert for inflation erosion as a policy choice.

Thanks, and see you next time!

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Asset Management Beyond the headlines Debt Emerging markets Global Inflation Public debt Supply Shocks