An Overview of Fiscal and Public Debt Dynamics
Immediate impacts of inflation on public finances
Inflated Nominal
Values
Indexation
Inflation
S
Sovereign Debt
Structure
Market
Expectations
M
M
GDP
Denominator
• Nominal GDP increases with
inflation lead to lower fiscal deficits
and public debt as a ratio to GDP.
Revenue
⚫. The nominal tax base also grows
with inflation (for example,
value-added tax and profit tax).
• If income tax brackets are not
indexed to inflation, taxpayers may
be pushed into higher tax brackets
(bracket creep).
(Source) IMF, 2023, Fiscal Monitor April 2023
Primary
Expenditure
• Primary expenditure does not
usually move immediately with
inflation. However, public
expenditure can go up with
inflation with a short delay via
indexation of public goods and
services (for example, public
wage, social benefits, subsidies,
pension, and medical expenses) to
inflation.
Interest Bill
and Debt Service
• Interest payments on inflation-
indexed bonds go up with inflation.
• Governments with more short-term
debt (S) than long-term debt (L)
face higher refinancing costs as
investors ask for higher returns to
compensate for expected inflation.
They pay higher interest on
foreign-currency-denominated
debt (F) than on domestic-currency
debt (D) when the currency
depreciates due to inflation.
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