Higher inflation would reduce the real value of outstanding government debt while increasing tax revenues.
Amid the IMF’s negative predictions for Spain’s economic growth in 2022 and 2023, coupled with constant and persistent inflation, there could be an unnoticed variable that brings with it a reduction in debt in conjunction with higher tax collection.
Paradoxically, the answer lies in inflation itself. Spain has projected the largest increase in nominal GDP so far this century, and all thanks to the cumbersome imbalance in the volume of prices.
In other words, the Nominal GDP is the reflection of the volume of prices, and therefore of the inflation rate. Higher inflation reduces the real value of outstanding government debt while increasing the tax burden on capital investment, due to the lack of inflation indexation. That is why the increase in nominal GDP would help reduce Spain’s foreign debt.
Inflation Trend in Spain
It is worth remembering that inflation refers to the increase in the price of goods and services, and this is directly proportional to the decrease that a currency sees in its purchasing power. While there are three types of inflation, they all lead to a gradual increase in prices over time. The three types are demand inflation, cost inflation, and core inflation.
Inflation, like all economic indicators, has its “silver side” – at least for governments and economic policymakers. In addition to reducing the country’s debt, governments generally agree that inflation increases tax revenues, which, like VAT, are set as an additional percentage of the price.
This trend could gain more and more strength in Spain, a country where its real GDP growth is declining, while the nominal GDP is not, which is experiencing unparalleled progress in more than two decades. In fact, the effect seems to have begun, since inflation has already reduced the Spanish debt by 9% of GDP, from 125% to 116% of GDP.
Largest Increases in Nominal GDP over Time
According to the analysis of the newspaper El Economista, the 4.4 points of real growth could be added up to 4 points or more of the GDP deflator (a much broader price indicator than the CPI), according to the new government ‘macro’ table.
This scenario would give rise to a nominal growth close to 8.5%, a variation rate not seen since 2000. That year, the real economy expanded by 5.2%, while the GDP deflator was 3.5%.
The hitherto hypothetical inflationary spiral would continue until 2024, causing recession and even havoc in some productive sectors. This would translate into a decrease in the real disposable income of Spanish households. In a context in which inflation does not seem to subside despite the constant rises in interest rates, nominal GDP is expected to reach its apex in the following quarters.
The real and most important question would be whether this would actually bring any benefits, given that inflation not only wreaks havoc on those with lower income levels but could also unleash an inflationary spiral that further damages production and the purchasing power of the general population.
In short, inflation, if well managed, need not be a bad thing. Citizens have many options to protect themselves against this event, through stocks, precious metals, or other investments, such as cryptocurrencies. It is a matter of researching well how to protect yourself from inflation.
By Audy Castaneda
