Higher inflation has bolstered advanced economies’ public finances, the IMF said on Monday, as it called on governments to use the windfall to cut deficits.
Research published by the fund showed that the surprise surge in prices over the past couple of years helped lower debt burdens substantially.
According to the IMF’s data, high inflation led the US’s net debt burden to fall from 99 per cent of gross domestic product in 2020 to 95 per cent in 2022, despite the country’s large pandemic-era budget deficits. Italy’s net debt burden fell from 142 per cent of GDP to 135 per cent.
But Paolo Mauro, deputy director of the IMF’s fiscal affairs department, warned that governments should not “count” on public debt burdens falling further because of so-called “surprise” inflation.
“You cannot keep surprising people,” he said, adding that fiscal authorities should lower budget deficits to help central banks bring high price rises under control.
High inflation delivered a public finances windfall partly because the surge in prices in 2021-2022 was more than expected by investors. Many lost out by lending to governments at low rates of return rather than demanding higher debt costs that usually accompany higher inflation.
The fund’s research estimated that an unexpected inflation increase of 1 percentage point would reduce the share of public debt in GDP by an average of 0.9 percentage points for countries with a debt burden of more than 50 per cent of GDP. Most advanced economies have debt burdens far in excess of this level.
But Mauro said the benefit of inflation to taxpayers at the expense of bond holders was unlikely to be repeated.
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The shock to prices owing to supply chain problems during the pandemic — and a surge in food and energy costs across Europe after Russia’s invasion of Ukraine — is now being priced into bond markets.
Yields on the US benchmark 10-year government bond have risen from 1.1 per cent at the start of 2021 to 3.5 per cent today, with similar rises across advanced economies and at all maturities of debt.
The estimates were published in an analytical chapter of the IMF’s Fiscal Monitor ahead of the fund’s spring meetings next week.
They also showed inflation helped bolster tax revenues, which tended to rise in line with prices. Public spending, by contrast was less sensitive to inflation and took a while to catch up.
While most advanced economies increase public pensions and social security automatically in response to higher inflation, most countries did not change thresholds in their tax systems or index public sector wages to inflation. That has helped to lower government deficits around the world with a disguised increase in taxation.
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Emerging economies and the poorest economies had little indexation in their public tax or spending systems. However, they benefited less from the surprise bout of inflation owing to their reliance on dollar funding.
The US currency has risen sharply in value in recent years, leaving emerging economies struggling to pay the higher costs of their debt.
The IMF’s research also indicated that reducing budget deficits can help curb price pressures, with a reduction of 1 percentage point of GDP leading to a 0.5 percentage point fall in inflation. It said that fiscal policy “can help” central banks reduce inflation.
“Well-targeted fiscal restraint can be designed to support monetary policy in attaining price stability while protecting the vulnerable from the cost of living crisis,” the IMF said.
Source: Economy - ft.com
