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Income must outgrow the interest rate
The growth bar
Take a country going through a deleveraging with a debt-to-income ratio of 100%, meaning its debt equals everything the country earns in a year. Say the interest rate on that debt is 2%. Debt grows 2% a year from interest alone, and if income grows only about 1%, the debt burden never falls.
Why printing offsets credit
So the central bank has to print enough money to push income growth above the rate of interest. Printing doesn't raise inflation if it offsets falling credit, because spending is what matters: a dollar of spending paid for with money has the same effect on price as a dollar of spending paid for with credit. New money makes up for credit that has disappeared.
The risk of too much
Printing is easy to abuse because it's so easy to do and people prefer it to the alternatives. Too much of it causes unacceptably high inflation, the way it did in Germany during its deleveraging in the 1920s.
Why does growth versus the interest rate matter?
Economist Evsey Domar showed in 1944 that when a government runs no primary deficit, its debt ratio falls over time if the economy grows faster than the interest rate on the debt. Olivier Blanchard revisited this in his 2019 presidential address to the American Economic Association, arguing that low interest rates had made large public debts easier to carry.
When the interest rate is higher than growth, the same debt ratio rises on its own.
Why didn't QE trigger inflation after 2008?
Most of the reserves created by asset purchases stayed parked at the Federal Reserve as excess bank reserves rather than becoming loans and spending. The Fed began paying interest on those reserves in October 2008, which encouraged banks to hold them. Meanwhile households and banks were paying down debt, so spending stayed weak.
US inflation, measured by the Fed's preferred gauge, ran below its 2 percent target for most of the years from 2009 to 2019.
How bad did Germany's inflation get?
In 1923 the German government financed its deficits by printing marks, including to support striking workers during the occupation of the Ruhr by French and Belgian troops. By November 1923 one US dollar was worth about 4.2 trillion marks.
The Rentenmark, introduced that month, ended the spiral.
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