23  In an effort to control debt levels incurred during the war, the British government ran huge primary surpluses during the 1920s, averaging 7% of GDP, with all the social and industrial unrest that entailed. Yet ratios of government debt to GDP didn’t fall, remaining at over 160% of GDP throughout that decade. Just as rapid inflations can eat up debt so deflations can increase it. The short-lived reinstitution of the gold standard (it was then abandoned for good in 1931) was heavily criticised at the time by Keynes. 24 The question was only formally considered – and a return to the pre-war parity recommended – by the Cunliffe Committee in 1918. 18  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  18  Chart 13a: To the extent fiscal variables matter for inflation government demand more important than debt  Chart 13b: Debt higher in wars than in 1970s but residual monetary credibility may have contained inflation, bond yields  Average debt/GDP; changes in central government expenditure less interest payments over nominal GDP; and average inflation. Sources: Thomas and Dimsdale (2017), Mitchell (1988), Feinstein (1998), O'Donoghue et al (2004), ONS and Bank calculations. Average bond yields based on consols/ long-term bonds. Sources: Thomas and Dimsdale (2017), Capie and Webber (1985), Neal (1990), Klovland (1994), Feinstein (1998), O'Donoghue et al (2004), ONS, DMO, and Bank calculations.
Over time, and as long as inflation is on average in line with prior expectations, the change in the ratio of debt to GDP (b) is given by (r – g)b – d, where d is the primary deficit. This is stable – for given d it tends over time to revert to a steady state level (b* = (g-r)/d) – only if the term multiplying b is negative, i.e. g > r. With risk-free real interest rates comfortably below zero in developed economies this condition seems to be fulfilled at the moment, though that’s not always been the case. When r > g the debt ratio is no longer stable – unless d changes accordingly, small changes in r or g would put b on an unstable path. For more on the implications of g > r see Blanchard (2019) and Mehrotra and Sergeyev (2019). 12  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  12  The blue line in Chart 8 depicts the results of a stylised experiment in which inflation rises permanently, and without any warning, by 1  Chart 8: Surprise inflations can reduce public sector debt though when g > r the effect is ultimately temporary  percentage point (from 2% to 3%). There’s a corresponding rise in inflation expectations, and therefore nominal interest rates and bond yields as well, but only at the time inflation itself goes up.