Going the other way, very rapid inflations have been bad for real output growth and they’ve also tended to push up the real cost of public-sector debt thereafter, via a higher risk premium. For those reasons, and even from the narrow perspective of the government finances alone, I think these  11  Giovannini and de Melo (1993). 11  All speeches are available online at www.bankofengland.co.uk/news/speeches and @BoE_PressOffice  11  simulations should be seen as relatively optimistic, at least over the longer term. But they do at least give us some sort of handle on the marginal effects of higher inflation. As a starting point, we should begin by recognising that if the extra inflation is fully anticipated it will have very little impact on the public finances. That’s because investing institutions, which care about real returns, could then take account of it in the price they’re prepared to pay for the debt. If everyone knew in advance that inflation was about to rise permanently by (say) 1% point you’d expect nominal yields to be 1% point higher, across the curve, than they otherwise would’ve been. In real terms, the government wouldn’t pay any less for its debt – the newly sold debt, at least – even after the inflation arrives. The real value of the principle declines by an extra one per cent a year. But the interest payments – the coupons – are also a percentage point higher.
All else equal – for a given setting of monetary policy – it was also disinflationary. Qualitatively, at least, the same thing is going on right now. Public sector debt has risen significantly, across the developed world, in response to the pandemic. But, as was the case after the financial crisis, this has not been caused by any material rise in governments’ spending on goods and services, or their direct demand for underlying economic resources. It’s because tax receipts have fallen sharply and, more materially, because governments have compensated people for the impact of mandated lockdowns. Private and aggregate demand have fallen, below the economy’s supply capacity – despite these huge transfer programmes, rates of unemployment and wider measures of spare capacity are rising. And it’s in response to these disinflationary pressures that independent central banks everywhere, including in the UK, have eased monetary policy. Anyhow, having set out at some length the points I want to make, I hope I can be reasonably concise in the body of this talk. I’ll cover first the cyclicality of interest rates under inflation targeting. Via some very simple simulations I’ll then look briefly at the impact of inflation on the public finances, focusing in particular on the effect of paying interest on central bank reserves. After an equally brief canter through some of the relevant bits of UK history there’s a short concluding section.