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One of the main problems of the world economy is the growing and very high indebtedness, mainly from the States. It is repeated ad nauseam that the onset of inflation would be the best way to reduce the high load of Debt.
It is argued that if there is inflation it will be easier to repay debts. I allow myself to question this premise what is considered almost like dogma. Inflation does not necessarily help to reduce debts, but, on occasions, the onset of inflation can lead to non-payment of debts.
It is understood by inflation the change in prices of a given basket of consumer products and services (CPI – Consumer Price Indices). The composition of the basket collects, in a weighted way, the set of goods and services that an average household uses for consumption, without considering investment expenses, or payments associated with the purchase of a home or mortgage payments.
Both the ECB and the Federal Reserve look a target level of inflation close to 2%. Now, this level is even taken as desirable average over a period of time. In such a way that, after having been below 2% inflation for years, the inflation was even at 3% for a while and the central bank would not raise interest rates.
Inflation may rise by different causes Y not all are positive for the population that suffers them. A rise in prices not necessarily due to greater dynamism of the economy. In fact, the only two times that inflation in the Eurozone has been above 3% (2008 and 2011) was due to a scale of the price of oil to $ 145 and $ 126, respectively. Both times the ECB raised interest rates.
A rise in prices of imported products leads to an increase in inflation without, for this reason, there being greater dynamism in the economy. In practice it involves a transfer of income abroad. It is equivalent to a payment of a tax collected by another State, reducing internal disposable income.
The inflacin can also be increased by a increase in domestic demand that push prices up. In the United States, with the large tax plans of direct aid to families and businesses, the risk of an increase in inflation is evident. It is estimated that American families have received, together, one trillion dollars ($ 1,000,000,000,000) more in rent in 2020 than the decrease in income from wages, thanks to the aid received. Additionally, spending has been reduced in that year by half a billion dollars. As a consequence, there is a saving stored in families, in just one year, of $ 1.5 billion.
With the new $ 1.9 trillion tax plan, whose approval could take place before the end of March, the The danger of a strong rebound in consumption and an immediate increase in prices is real.
Going back to debatable premise of the greater ease of repaying debts if there is inflation, this premise is not necessarily true. It will only be so, as long as the debtor’s income increases at least by the same proportion as inflation.. If not, the debtor will have to dedicate most of his income to expenses increased by the increase in inflation, having less disposable income to pay his debts.
A family with consumer or mortgage debts don’t see your income increase with inflation, given the rise in the CPI You will have less disposable income to meet the periodic payments of the debts. Additionally, in the case in which the interest rate applied to the payment of debts increases with inflation, the problem worsens, by having to allocate a greater amount to the payment of interest.
In the case of a company the situation is similar. Nothing ensures that an increase in the costs it bears can be passed on in the same proportion to the sales prices. Therefore, If income does not increase by the same or greater proportion than expenses, the amount available to reduce debts is reduced.
The Public Administrations play with advantage. The Increased inflation does generate more income for them, simply by not deflating the tax rate. For example, if a worker sees his salary increase in the percentage of inflation, for the purposes of personal income tax it is possible that he will be taxed at a higher rate, paying more taxes and, consequently, reducing his purchasing power.
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Although the theme of imminent inflation is recurrent (see articles on the same topic of 2016, 2019), this time there are elements to consider that during this year 2021 we will witness strong price rallies, at least in Germany and the USA In any case, neither the Federal Reserve nor the ECB will raise interest rates.
As has been commented, debtors do not always benefit from inflation. The one who does inevitably lose out is the most conservative saver. With inflation and zero or even negative interest rates, the loss of purchasing power increasingly pushes you to become an investor and take risks.
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