Inflation and Public Finances

Economists focus on ‘real’ magnitudes, or those that are measured in a way that removes the effects of inflation. Standard national accounting procedures are designed to capture both real volume measures and ‘current price’ measures by deflating nominal values by an appropriate price index. However, in the realm of public finances, there has been something of a blind spot when it comes to inflation adjustment and standard statistics do not account for the effect of inflation. At the same time, the impact of inflation can be considerable since the bulk of government liabilities are denominated in nominal terms. There is thus an ‘inflation tax’ reflected in the reduction in government liabilities in real terms (and corresponding reduction in the real value of the assets of the bond holders).