Inflation and the Debt/GDP ratio

Jan 16 12:01 2019 Print This Article

I'm trying to write a simple explainer. The best way to understand how inflation affects the debt/GDP ratio is to start out with a scenario where it doesn't. Then look at ways in which the real world is not like that scenario.

Here's the "No Effect" scenario: The Bank of Canada suddenly decides to raise the inflation target by one percentage point (1ppt). Like from 2% to 3% (which is a 50% increase, which is why I'm being picky and saying 1 ppt instead).

Assume that inflation immediately increases by 1ppt, but real GDP (RGDP) growth is not affected, so nominal GDP (NGDP) growth immediately increases by 1ppt.

Assume that expected inflation also immediately rises by 1ppt, and that nominal interest rates also immediately rise by 1ppt (because borrowers and lenders only care about real interest rates, which are unaffected in this scenario).

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A Worthwhile Canadian Initiative

Group economics blog written by Canadian Economics professors and authors from the University of Laval, Carleton University, Richard Ivey School of Business, and Lakehead University

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