In 2022, the higher inflation is expected to increase the public debt burden

Higher inflation is deemed to reduce the public debt burden as it increases the denominator of the public debt-to-GDP ratio in value terms, thereby making it easier to repay any debt inherited from the past.

However, aside from this positive “mechanical” effect, the impact of higher inflation on the public debt-to-GDP ratio is more complicated. The public debt trajectory is dependent on the extent to which interest rates and the primary balance adjust to higher inflation.

In the medium-term, the impact of higher inflation on the public debt-to-GDP ratio will be positive or negative depending on whether interest rates rise faster or slower than inflation, through changes to monetary policy and risk premiums.

Even in the short-term, the impact is not necessarily positive, as seen in 2022. A series of factors must be considered: the “mechanical” effect is clearly positive, but it has ultimately been fairly limited in 2022, particularly because of the largely imported nature of current inflation; the support measures put in place by the Government will increase the public deficit, as will the higher interest expenditure; finally, the growth shortfall from higher prices and interest rates will also have an adverse effect on public finances.

All in all, after accounting for the full impact of inflation on public debt, it appears that the excess inflation seen since the initial budget law for 2022 will increase, not decrease, the public debt ratio by around 1.2 GDP points in 2022.

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