Today, the US faces an unsustainable debt trajectory. By end of the next 10 years, the Congressional Budget Office (CBO) projects America’s debt-to-GDP ratio will approach 120% under current law, surpassing the prior record reached in 1946.
If expiring tax policies are extended without offsetting deficit reduction, debt would end the decade even higher. Given this moment of heightened consumer price sensitivity and fiscal crossroads in the policy, the interplay between debt & deficits and inflationary pressures merits renewed scrutiny.
For decades, low and stable has served as a bedrock of economic policy in advanced economies. This has been a long, hard-learned lesson.
From the hyperinflation traumas of mid’s of 20 century to the stagflation shocks of the 1970s to the global pandemic inflation, policymakers have been reminded time and again that price stability is not merely a technocratic objective on paper but a prerequisite for sustainable growth, equitable resource allocation, and public trust in economic institutions.
This paper argues that
elevated federal debt increases the risk of inflationary pressure through several channels in both the short- and the long-term.
Overview: Why Low Inflation Remains a Policy Priority
At its core, inflation can act as a stealth tax on economic certainty. When prices rise unpredictably, households face a dual burden: first, the erosion of their nominal incomes, and second, heightened uncertainty about future purchasing power.
Lower-income households bear these uncertainty costs disproportionately, as they allocate larger shares of their budgets to non-discretionary items like food and housing—categories less flexible for substitution and particularly vulnerable to supply shocks, though it is not clear that low-income households always bear more of the actual costs of inflation.
Equally corrosive is inflation’s impact on decision-making frameworks. When businesses and consumers cannot distinguish relative price changes from economy-wide trends, resource allocation grows inefficient. Firms delay investments, households hoard goods, and lenders demand higher risk premiums—a dynamic starkly visible during the 1970s “Great Inflation,” when annual U.S. PCE price growth averaged 6.6%, versus 2.2% over the 1960s. Research shows that higher inflation volatility can detract from growth, especially among countries with records of high inflation and low-credibility central banks.
An important detail to note is that in reality, the nature of the debt shock matters in the long-run.
Here, we are simulating a generic debt shock which solely has crowd-out effects on private investment, to isolate the debt effect. Debt-financed policies however may have countervailing positive effects on the capital stock and labor supply over time, such as infrastructure spending or effective childhood interventions – or in the case of a recession.
