Can we inflate away government debt in 2025?

Government borrowing surged in the wake of the pandemic, leaving many countries with historically high levels of public debt.

By Dan Mitchellan hour ago Updated

As policymakers weigh how best to manage these obligations, some have revisited the idea that inflation could help ease the burden. Yet, in today’s economy – shaped by inflation-targeting central banks, globalised markets and inflation-linked bonds – the relationship between rising prices and debt reduction is far more complex.

With global public borrowing still elevated after the pandemic, governments face a dilemma: can inflation meaningfully reduce debt burdens, or has that era passed?

Government debt remains historically high

Government debt is once again front-page news. Global borrowing has risen sharply in recent years, with the IMF warning that debt-to-GDP ratios are likely to stay high for the foreseeable future (IMF). The US national debt has now surpassed $38 trillion, with a debt-to-GDP ratio near 120% (Fortune, 17 November 2025).

Borrowing costs have remained elevated as central banks keep monetary policy tight, even as inflation moderates. Across advanced economies, fiscal pressures persist, driven by higher interest payments and pandemic-related spending (The Economist, 13 September 2025).

In the UK, inflation has slowed to 3.6%, offering only limited relief for policymakers. Debt remains above 95% of GDP, and the government continues to face calls to balance fiscal discipline with social spending priorities (ITV News, 19 November 2025).

In the EU, the bloc’s revised fiscal rules are set to become permanent, acknowledging that many member states still exceed the 60% debt-to-GDP ceiling (The Economist, 13 September 2025).

The danger of deficits

A government’s deficit is the annual shortfall between its income and expenditure, while national debt is the accumulated total of those shortfalls over time. When this debt grows too large relative to GDP, markets may question a government’s ability to meet its obligations.

Between 2022 and 2025, most developed economies recorded ongoing fiscal deficits, reflecting the continued cost of energy subsidies, healthcare spending and defence commitments (BBC News, 21 October 2025). While the risk of outright default remains low in major economies, concerns about debt sustainability have re-emerged in some emerging markets, widening global fiscal divides (The Economist, 13 September 2025).

Driving down the debt

Reducing national debt is economically and politically complex. Governments can pursue several approaches, each with trade-offs.

Economic growth

Higher growth expands the tax base and lowers the debt-to-GDP ratio. However, with global growth slowing to around 2.5%, this route is uncertain (CaixaBank, 17 November 2025).

Austerity and spending restraint

Austerity remains unpopular and, in some cases, counterproductive, as demand for public investment and infrastructure stays strong (Berenberg, 1 August 2025).

Tax reform

Some governments, including the UK, have introduced targeted tax rises, though comprehensive reform remains politically challenging (OBR, 26 March 2025).

Can we inflate away the public debt?

At first glance, higher inflation may appear to reduce real debt burdens. The logic is straightforward: as prices rise, the real value of existing debt declines. However, the conditions that allowed post-war economies to inflate away debt no longer apply.

Today, much government borrowing is short-term or inflation-linked, meaning inflation often increases, rather than reduces, interest costs. In the UK, about a quarter of government debt is inflation-linked, while similar instruments – such as TIPS in the US – have grown steadily in recent years (HM Treasury, 2 April 2025).

Central banks remain committed to price stability despite fiscal pressures. The Bank of England’s November 2025 Monetary Policy Report reaffirmed its 2% inflation target and stressed the importance of central bank independence, even amid political debate about its limits (Bank of England, 5 November 2025).

Key takeaways: costs of inflation

Inflation reduces the real value of existing debt but can increase nominal government spending, particularly through wage and benefit indexation. In the UK, where public sector pay and pensions are partly linked to inflation, higher prices directly raise fiscal costs.

Rising inflation-linked debt further limits any fiscal advantage from inflation.

In short, while inflation can still erode debt in theory, its real-world impact is smaller in today’s financial environment, where markets adjust quickly and governments must refinance at higher nominal rates.

This article is provided for informational purposes only and does not constitute investment advice or a recommendation to engage in any financial transaction. The information presented reflects data and analysis available as of November 2025 and may change without notice. Past performance is not a reliable indicator of future results.

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FAQ

How does inflation reduce debt?

Inflation can reduce the real value of government debt by eroding the purchasing power of money. When prices rise, the money used to repay existing debt is worth less than when it was borrowed. However, in modern economies, a large share of public borrowing is either short-term or inflation-linked, which limits how much governments can benefit from higher prices.

How does inflating away debt work?

Inflating away debt occurs when higher inflation allows governments to repay debt in currency that has lost some of its real value. This approach was more effective in the post-war period, when inflation was elevated and most debt carried fixed interest rates. Today, it’s less viable because central banks target low and stable inflation, and an increasing proportion of public debt automatically adjusts to inflation.

How can governments solve a debt problem?

Governments can address high debt levels through a mix of strategies, including supporting sustainable economic growth, containing public spending, and reforming tax systems. Sustained inflation or austerity alone is unlikely to deliver lasting results. Many economists now expect balanced fiscal reform – combining growth initiatives, selective tax measures, and responsible borrowing – to remain the most practical approach.

Is high inflation a sustainable way to manage debt?

Unlikely in the long term. Persistent inflation raises debt servicing costs, particularly for inflation-linked bonds, and increases government spending on wages and benefits. Most central banks remain committed to price stability, making it improbable that high inflation will be used deliberately as a debt-management tool.