In recent years, the main Cream Banks have emphasized the need to create inflation in order to reduce the burden of debt. To do this, they have put into circulation huge amounts of liquidity that more or less have achieved the desired effect, creating inflation.
But what is the relationship between inflation and debt or loans? Although many people do not notice it, there is much more relationship than a priori seems.
Debt Burdens Go Down
Inflation is nothing more than a general increase in the general price level of a given country. In other words, inflation represents the reduction in the purchasing power or value of a currency since with the same amount of money we can acquire fewer goods or services.
When it comes to loans, inflation means a reduction in the burden of debt. In effect, since the debts represent the same amount over time and the value of the currency is less, the creditor will receive a lesser amount in real terms, that is, he will be able to acquire fewer goods or services when the borrower returns the loan.
For the debtor, on the other hand, inflation represents a reduction in debt burdens. If your salary is linked to inflation, you will have a higher disposable income for the same level of debt. In other words, you can allocate a higher income to pay your debts, which in the end is nothing more than a de facto reduction in the burden of this debt.
Inflation and loans: case study
For example, if we have a debt whose total amount (including capital and interest) is 12,000 USD over ten years and our salary of 1,000 USD per month, we will allocate 100 USD a month to pay this debt, that is, 10% of our salary.
If inflation is 2% and our salary is linked to inflation, next year our salary will increase 20 USD per month, that is, our income will be 1,020 USD per month. If we allocate the same amount of money to pay this debt in percentage terms, we will pay 102 USD of monthly installment for the same debt, 10,000 USD in ten years.
In other words, instead of using ten years to pay our debt, we will finish paying the last installment at 9 years and 9 months, reducing the total time by 3 months. The higher the inflation, the lower the debt burden.
In reality, calculating the incidence of inflation on loans is much easier, since it is only necessary to subtract the interest on the loan from the level of inflation. If the interest is 5% and inflation is 2%, the real debt burden measured by the real interest that the debtor will pay is 3% (5% -2%).
The higher the inflation, the lower the debt burdens will be. This has a contrary impact on savings or the amount borrowed by the lender. Inflation reduces the real savings of families and companies in the same proportion.
This is the fundamental reason why countries and Cream Banks seek reasonable levels to avoid an increase in the real burden of debts that makes it difficult to repay them.