Abstract
Abstract This paper proposes a new method for measuring the impact of inflation on the real value of public debt. The distribution of debt debasement is based on two inputs: the distribution of privately held nominal debt by maturity, for which we provide new estimates, and the distribution of risk-adjusted inflation dynamics, for which we provide a novel copula estimator using options data. We find that inflation by itself is unlikely to lower the U.S. fiscal burden significantly because debt is concentrated at short maturities and perceived inflation shocks have little short-run persistence and are small.
Highlights
This paper proposes a new method for measuring the impact of inflation on the real value of public debt
The probability of the real value of debt falling by at least 1% of gross domestic product (GDP) due to inflation is 47%, but anything more than a mere 3% of GDP has the small probability of 5.5%
This paper presents and implements a new method to evaluate the effect of higher-than-expected future inflation on the real value of debt
Summary
This paper proposes a new method for measuring the impact of inflation on the real value of public debt. A common way that sovereigns pay for high public debt is by having high, and sometimes even hyper, inflation (Reinhart and Rogoff 2009). Whether this is feasible or likely in the future is an open question. We propose a method to quantify the likelihood of future inflation substantially eroding the real value of current public debt. We measure the effect of inflation on the fiscal burden by constructing the distribution of inflation-driven debt debasement. We show how to map the distribution of debt debasement into central objects in theories of inflation and its effects
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