Suppose that there are two countries (Ireland and Belgium) negotiating the government debt criteria for the Eurozone. Ireland has a high ratio of government debt to GDP; Belgium has a low ratio of debt to GDP. Which country is likely to prefer a higher inflation target?

Question

Quizplus · Accepted Answer

Ireland is likely to prefer a higher inflation target because its high debt-to-GDP ratio means that even a small reduction in the real value of its debt can have a significant impact on its debt burden. Inflation reduces the real value of debt, so higher inflation can cause larger absolute reductions in the real value of Ireland's government debt compared to Belgium's. Belgium, on the other hand, may prefer a lower inflation target as it already has a low debt-to-GDP ratio and may not benefit as much from reducing the real value of its debt through inflation.

Suppose That There Are Two Countries (Ireland and Belgium) Negotiating