What -- It only works with Federal Debt?

 

"In 1946, the debt ratio was 108.6 percent. Inflation reduced this ratio about 40 percent within a decade." 

"The model predicts that a moderate inflation of 6 percent could reduce the debt/GDP ratio by 20 percent within 4 years."

 - Joshua Aizenman and Nancy Marion

 

In the above quotes, Aizenman and Marion refer to the ratio of Federal debt to GDP.

The excerpt below begins on page 8. I have shortened the quote by omitting their parenthetical data; and again, they refer exclusively to the Federal debt:

A few observations are worth noting.  Inflation yielded the most dramatic reduction in the debt/GDP ratio—and the real value of the debt—in the immediate post-World War II period.  A five-percent inflation increase starting in 1946, for example, would have reduced the debt/GDP ratio from 108.6 percent to 59.3 percent, a decline in the debt ratio of 45 percent.  The sizeable inflation impact is not that surprising.  Not only was there a large debt overhang when the war ended, but inflation was low and debt maturity was high.  Thus there was room to let inflation rise... 

In contrast, inflation would have had little impact on reducing the debt burden in the mid-1970s after the initial oil price shocks.  That period was characterized by a lower debt overhang, inflation was higher, and debt maturities were shorter.  As a result, in 1975 a 5 percent inflation increase would have reduced the debt/GDP ratio from 25.3 percent to 21.9 percent, less than 15 percent.  

The factors they mention do seem important. Note in particular that in 1946 "inflation was low (2.3%)" and that in the mid-1970s "inflation was higher (11 percent in 1974)". So the crux of the matter is not entirely that "inflation would have had little impact on reducing the debt burden in the mid-1970s". In good part, it is that inflation actually did reduce the debt-to-GDP ratio in the 1970s. Not so much the Federal debt, which was then low, but private sector debt, and so that of the whole nonfinancial sector.

Note that the title of Aizenman and Marion's paper is "Using Inflation to Erode the U.S. Public Debt". Their focus is on the use of higher inflation as a tool for the reduction of the debt-to-GDP ratio in our time. This is one reason they point out that it works better when inflation is low than when it is high: because then there is "room to let inflation rise".

As for myself, I wouldn't be caught dead thinking of inflation as a potential tool to reduce the burden of debt. I see inflation not as a tool but as a problem. My focus is not on the use of increased inflation as a tool for the reduction of the debt-to-GDP ratio, but on the actual result of the actual inflation during the years of the Great Inflation, when inflation was high. 

The debt-to-GDP ratio remained low in those years, because of the inflation.