The gamble of trying to inflate away debt | The Indicator

The hosts examine Donald Trump’s suggestion that the United States could “inflate away” the more than $40 trillion national debt, and explain why the idea only works under very specific conditions. An economist from the London School of Economics argues that inflation can reduce the real value of fixed-dollar debt, but only when the inflation is unexpected and lenders have not already priced it in.

The episode points to the post-pandemic period as a real example: inflation in 2021 and 2022 reduced the government’s real debt burden because Treasury rates had been low before prices surged. But once inflation is anticipated, bond investors demand higher yields, which offsets the effect and can even destabilize the financial system. The guest says that in places like Latin America in the 1980s, expected inflation spiraled into higher rates and worse economic damage.

The hosts also explain that governments can sometimes suppress borrowing costs through “financial repression,” such as steering pension funds and banks into government bonds, as the U.S. did after World War II. Even then, the guest says the recipe is hard to pull off: the debt must be long-term, not indexed to inflation, and inflation has to persist long enough to erode it. He says investors still appear to trust the Federal Reserve to keep inflation near 2%, making a deliberate debt-inflation strategy unlikely to work.