Inflation: The Dragon That Burned The Debt Pile

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Treasurer Jim Chalmers’ first budget shows his attempt at saving to ease the burden of increasing inflation. However, this is not enough. Australia still sees mounting debt and expects deficits for the years to come.

However, some economists say that inflation may help the country reduce debt significantly. Australia’s current financial situation is very similar to its post-WW2 condition. In the fifties, the country had a considerable debt. The government had to borrow money from its citizens at meagre rates, resulting in 120% debt-to-GDP.

As the interest rates increased, money brokers thought they wouldn’t be able to repay the debt. But the inverse happened. In the seventies, the war debts were eliminated. “Part of it was the tighter fiscal policy that reduced the growth in gross debt, but the main magic trick was high inflation, which obliterated the debt in nominal terms,” notes Senior Reporter Jonathan Shapiro.

Economist Michael Blythe notes that higher inflation rates will help Australia as it did years ago. Higher inflation is expected to boost the growth of nominal GDP and reduce the debt-to-GDP ratio. “The official figure has the net debt GDP ratio at 28.5% in 2025/26. But that ratio would be more than two percentage points higher if inflation rates were two percentage points lower,” Blythe adds.

Blythe also describes that higher inflation helps government bonds gain higher yields, adding, “The mechanics of bond pricing means that price of government debt is inversely related to the yield. Higher yields mean lower prices, and the value of debt outstanding falls.”

As the RBA forecasts inflation to peak at 7.75%, the economist determines the government spending program indexed to inflation will need an additional $30 billion in the next four years. This will fund JobSeeker, family assistance, carers and disability support, and the age pension. Blythe predicts that since the government revenue is leveraging high inflation, the result should be net positive for the bottom line.

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