Monetary policy is not the only economic mechanism driving inflation. Government debt creates inflationary pressures in at least three ways. First, rising government deficits represent an increase in aggregate demand over supply. While small increases in the deficit have little impact on price levels, large increases in deficits can have a big impact. Second, by shifting resources from the more productive private sector to the public sector, government spending can reduce productivity and increase the bias in the economy towards inflation. And lastly, the greater the debt as a share of GDP, the greater the temptation a government has to inflate its way out of that debt.
Authors: Carl Steidtmann, Dan Latimore, Elisabeth Denison
Source: Deloitte Review