"Regular readers will
know the mantra "inflate, stagnate, default" that this writer has
perceived to be the three likely outcomes of the debt crisis. Now Marco Valli,
the euro zone economist of Unicredit, the Italian bank, has produced a very
interesting 27-page note on the issue. To give the game away, the title is
"Inflating away the debt overhang? Not an option". Mr Valli argues
that a central bank trying to achieve this aim would face three challenges:
1. to create inflation in the current context of large economic slack and private/public sector deleveraging
1. to create inflation in the current context of large economic slack and private/public sector deleveraging
2 to do so in a way that faster inflation leads to
negative real interest rates, thus generating a transfer from investors to the
government
and 3 to deliver negative real rates that are
sufficiently large and/or last sufficiently long to allow for a significant reduction
of the debt/GDP ratio.
Mr Valli argues that 'it is virtually impossible to
satisfy these three conditions in a low-growth, high-public-deficit
environment'. Of course, in a strong growth, low deficit (better still, a
primary surplus) environment, there would be no need for a central bank to take
the risk of attempting to inflate the debt away."
