Inflation is not only bad for states. This could reduce Austria’s mountain of debt by more than 30 billion euros.

One’s sorrow, another’s joy.

Inflation, which has soared to more than 7 percent, is worrying many people. Inflation is a social problem because it affects those on low incomes in particular, whether it is for daily shopping or the monthly electricity bill.

Inflation is also costing purchasing power overall, making consumers cautious. Last but not least, inflation eats up savings, because there has been no interest in the bank for a long time. But there is a second side to inflation: if money becomes less valuable year after year, debt becomes less valuable as well. And the higher the inflation, the more pronounced this effect is.

It is found in the debts that individuals have taken out as loans and in government debts – which are often gigantic sums.

Not in Macau, Hong Kong or Brunei. The two Chinese special administrative zones and the oil-rich sultanate have no de facto debt.

Extreme levels of debt

The situation is different in Portugal, where the debt level is 127 percent, or in Italy with 150 percent, or in Greece with debts even amounting to 193 percent of the country’s economic output (GDP).

Borrowers and highly indebted countries are therefore hoping that interest rates will remain low and that inflation will remain at the high level for a long time or even rise further. Because then a part of the mountain of debt will disappear by itself.

Economist Marcell Göttert from the liberal business think tank Agenda Austria has now calculated for the KURIER what that means for Austria. So how much the republic saves on debt service due to inflation.

The starting point is Austria’s mountain of debt at the end of 2021. 334 billion euros or 83 percent of GDP have come together over the many years. Years in which no budget surpluses were achieved even when the economy was booming.

Göttert’s calculations show that with inflation of six percent this year and four percent in 2023, the “loss in value” of the mountain of debt will amount to around 30 billion euros. If inflation is one percentage point higher in both years – i.e. seven percent this year and five percent in 2023 (roughly current forecasts) – the loss in value of the debt mountain will be 34 billion euros.

The expert also shows that if the debt burden remained at EUR 334 billion, the debt ratio would fall to 77% this year with an inflation rate of 7%. If inflation is 5% next year, the debt ratio will fall further to 74%.

However, this calculation assumes that real economic output will not change. So if there were a recession this year, the rate wouldn’t fall as much.

100 becomes 80

These are complex issues, no question. But there is a very simple logic behind it.

An example: If you owe 100, you still have to pay back 100 10 years later. But the original 100 is then no longer worth 100, but maybe 80 in real terms (if inflation was 20 percent during this period).

What complicates matters is the interest rates.

If you have a fixed-interest loan as a private individual, rising interest rates don’t matter. Here one benefits from the devaluation of money due to inflation (as long as income keeps pace). With variable rate loans, the borrower has to hope that interest rates will not rise too much.

Race against time

It’s different for states, they don’t get fixed-interest loans. Your bonds always “pay interest” again, depending on the point in time, creditworthiness, interest rate and market environment, etc. That means: If a country has borrowed in the long term during the low-interest phase, it is relatively well protected, like Austria. Countries that take on short-term debt will soon have to issue new bonds to refinance the old ones and may then be paying higher interest rates.

So in order to inflate away debt, interest rates must stay low and inflation high, or the effects will cancel each other out. This results in a “race against time”, says the German DZ Bank.

That’s one of the reasons why the European Central Bank, at least so far, is opposed to higher interest rates to combat inflation. Higher interest rates usually harm the economy. And Italians, like Greeks, could run into a new debt trap.

By Editor

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