Chair of the UK’s Office for Budget Responsibility, Richard Hughes, has warned that high inflation will not benefit Britain’s public finances as it has in the past. He explained that government debt is now more sensitive to changes in interest rates and prices, rendering the old notion of inflating away public debt ineffective. The average effective maturity of British government debt has decreased from seven years in 2008 to just two years. This means that higher interest rates now impact the cost of government debt more quickly than before. The Bank of England’s quantitative easing program has contributed to this shift by replacing longer-dated government bonds with short-term central bank reserves, linked directly to the bank’s bank rate. Additionally, approximately a quarter of Britain’s government bond stock is linked to inflation, the highest share among major advanced economies. As a result, the state must increasingly compensate investors as consumer prices rise. Hughes emphasized that inflationary pressures are becoming more embedded in the economy, with Britain experiencing the highest rate of consumer price inflation among major advanced economies in June, at 8.7%. The country had previously seen high inflation during the mid-1970s and much of the 1980s, but during that time, the headline measure of public sector net debt as a share of economic output decreased from about 49% to 22% in the early 1990s.
Outdated Beliefs on Inflation Fail to Tackle UK’s Debt Crisis
“UK’s Office for Budget Responsibility Warns High Inflation No Longer a Solution to Boost Public Finances, Citing Sensitivity of Government Debt to Interest Rates and Prices”