Who among us hasn’t heard of the mounting U.S. national debt and the threat it poses to this country’s future? There are really only three ways of bringing this debt under control: (a) by collecting more taxes, whether by raising the tax rate or increasing the GDP at the current tax rate, (b) by cutting government expenditure, and (c) by printing money to pay off debt, an inflationary measure. More liberals favor the first, more conservatives the second—both are harder to justify in recessionary times. The third option works rather differently and is not any more popular. Raghuram Rajan, Professor of Finance at the University of Chicago, takes a closer look at this option.

Recently, a number of commentators have proposed a sharp, contained bout of inflation as a way to reduce debt and reenergise growth in the United States and the rest of the industrial world. Are they right?

To understand this prescription, we have to comprehend the diagnosis. As Carmen Reinhart and Kenneth Rogoff argue, recoveries from crises that result from over-leveraged balance sheets are slow and typically resistant to traditional macroeconomic stimulus. Over-levered households cannot spend, over-levered banks cannot lend, and over-levered governments cannot stimulate.

So, the prescription goes, why not generate higher inflation for a while? This will surprise fixed-income investors who agreed in the past to lend long-term at low rates, bring down the real value of debt, and eliminate debt “overhang”, thereby re-starting growth. It is an attractive solution at first glance, but a closer look suggests cause for serious concern

More here.