Public Debt and Inflation: A Review of International Literature

Abstract

Abstract Research background: Public debt arises mainly from debt-financed deficits. More and more countries are resorting to additional public indebtedness to raise additional financial resources to meet government funding needs, which are unattainable by the usual tax means. As a result, increasingly, government spending is rising faster than revenue is received, and the excess is financed mainly through domestic and external borrowings. Expensive borrowings by a government (in an environment of increasing interest rates) may be harmful to inflation and the macroeconomic stabilisation process. This trend is raising concerns among policymakers as it undermines macroeconomic stability, especially in developing economies with relatively weak and dependent monetary authorities in the formulation and implementation of monetary policies. Hence, the association between public debt and inflation is of importance in the inflationary process of an economy. Purpose: In this paper, theoretical and empirical literature on the link between public debt and inflation has been surveyed in detail. The focus of the paper was centred on the review of literature on the link between total public debt, external public debt, domestic public debt and inflation. Research methodology: This paper presents an extensive review of scholarly studies on the link between public debt and inflation based on their results. The paper analysed, synthesised, and critically evaluated previous studies on the relationship between public debt and inflation on both the theoretical and empirical fronts. Results: The literature reviewed revealed the association between public debt and inflation. The surveyed literature shows that the relationship between public debt and inflation varies from country to country, with either a positive or negative relationship. However, in the majority of the literature, the link between public debt and inflation tilts towards a positive relationship. This finding is more prominent in indebted countries with higher levels of public debt and a less-developed financial market. Although there is no consensus on the positive or negative relationship between public debt and inflation, the study found that a positive relationship between public debt and inflation tends to predominate among the studies reviewed. Novelty: The study provides an insight into the relationship between public debt and inflation based on a detailed review of literature on the subject in both developed and developing economies.