Debt Adjustment without Inflation?

The future rate of inflation is one of the prime factors considered as countries attempt to deleverage their national debts.  Higher rates of inflation benefit the debtor and the expense of the creditor, especially if the interest rates on that debt are fixed.

For debtor nations, increasing inflation rates help ease the deficits.  According to the latest Merill Lynch RIC Report, the nations of France, Spain, Italy and Portugal expected higher rates of inflation than they are currently experiencing.  The GDP deflator growth of these countries have been especially low (p. 10).  Portugal actually experienced deflation in 2012 and Italy is expected to have a 0% inflation rate for this year.

See the table on page 10 below via the hyperlink.

Deflationary forces not only increase the burden of a federal deficit, but prolonged deflation increases unemployment.  As individuals enact personal austerity measures, they buy less and save more.  There is less of a need for the production of goods and services.  The surplus that exists needs to be sold at lower prices which continues the downward cycle.  This is all assuming that these goods and services are worthy of purchase and cannot be sold elsewhere.  Also it is taken as a given that labor does not flow freely between national borders.

However, the BofA Merrill Lynch Global Research predicted that there would be a 1.7% rate of inflation for Portugal in 2013, in comparison to the former year’s deflation rate of -0.3%.  Since unemployment rates are counter-cyclical trends, a higher than normal rate could be expected.  Luís Salgado de Matos summarizes here the current Portuguese labor trends.

Unemployment can also be considered pro-cyclical when it causes a credit crunch.  If the unemployed cannot access credit, they begin to spend even less, further reducing the price of goods.

Portugal is also interesting to study because it not only requested financial assistance from the EU, but also from the FMI.  Here are the official memorandums that were used to begin the bailout.

One response to “Debt Adjustment without Inflation?

  1. Pingback: Deflation First, Then Inflation | peterabraldes

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