Morgan Stanley: Here's Why Inflating Our Way Out Of Debt Will Fail Miserably

Morgan Stanley thinks that it is impossible for the U.S. to successfully inflate itself out of its debt problem, even if it wants to, because three key hurdles are preventing it:

  1. Even stealth inflation would push up treasury yields.
  2. Nearly half of government spending outlays are linked to inflation.
  3. The Fed is unlikely to give into this type of policy. (Yes, we can hear some readers laughing)

Even just hurdles #1 and #2 are enough to prevent the U.S. from inflating its way out of debt since there is a limit to the level of treasury yields the U.S. can handle paying out. It also doesn’t help your financial picture when you increase your future liabilities (in the form of inflation-indexed government outlays) while trying to escape your debt.

Richard Berner @ Morgan Stanley: The lesson of the 1970s: The Great Inflation did erode real debt, but perhaps by less than it appears. More important, the US post-war experience was anomalous: A rapid decline in defence spending yielded a significant ‘peace dividend’, monetary policy was then designed to hold down interest rates, and restrictions on Treasury debt issuance also brought down debt/GDP by restraining rates and debt maturities.

Inflation likely will push up US deficits: Social Security, which accounts for one-quarter of federal outlays, is officially indexed, and Medicare and Medicaid are ‘unofficially’ indexed. Together, these programs will account for nearly half of all federal outlays in the next decade.

Already, servicing even the same nominal amount of debt is set to get increasingly expensive:

Chart

(Via Morgan Stanley, US: Why We Can’t Inflate Our Way Out, Richard Berner, 24 Feb 2010)

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