Deutsche Bank has reminded us that the classic formula for reducing government debt is a sustainable primary surplus coupled with strong economic growth. The problem is that both of these tools appear more theoretical than realistic for most countries under contemporary political conditions.
Against this backdrop, inflation is re-emerging — not as a catastrophe, but as a potential mechanism to alleviate debt burdens. Rising prices decrease the real value of already accumulated obligations, allowing governments to repay debt with "cheaper" future money. This is particularly relevant for fixed-rate debt, which becomes notably easier to service in the context of sustained income growth.
However, this effect works only under one condition: if central banks do not respond to inflation with aggressive interest rate hikes. Here is where the optimism fades. Analysts note that the benefits of inflation in most historical instances have been almost entirely offset by growing yields — precisely the mechanism designed to keep inflation in check.
Moreover, the experiences of different countries vary significantly: in some cases, inflation has indeed helped lighten the balance sheet, while in others, rate hikes have merely increased the debt burden and required stricter budget discipline.
Deutsche Bank emphasizes that inflation becomes an effective tool for debt reduction only when yields can be managed. This area falls squarely within the realm of monetary policy — from direct limits on interest rates to softer forms of financial repression. However, such an approach is only feasible in a context of high national debt, control over capital flows, and a compliant central bank.
In other words, inflation can be helpful, but only if it is not treated too aggressively. For most countries, it remains an imperfect but the most realistic tool for reducing accumulated debt, though on the condition that authorities successfully prevent borrowing costs from rising too sharply.
