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T.E.D. commented on this answer:

Sometimes (particularly in developing countries) they literally are printing more money. In the USA typically we increase the money supply to make up for some kind of undesirable market tightening (which in theory should not cause much inflation). In developing countries, it is often done just to inflate away domestic debt. It doesn't hurt the decision makers any, as they can hide their assets in foreign currency. But it absolutely trashes domestic savings.

(Emphasis mine.)

What are the advantages and disadvantages of inflating away domestic debt by literally printing more money?

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You really need to be more specific with your question. It is difficult to discern what you are asking and try to answer it. –  ihtkwot Aug 12 '12 at 23:13
    
@ihtkwot - I am sure it is better now, sorry for the inconvenience –  Victor Aug 13 '12 at 0:11
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@Victor Fixed it for you, and removed the rhetorical flamebait while I was at it. –  SevenSidedDie Aug 13 '12 at 0:22
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@Victor Don't thank me; I did it for the good of the site. The important part of my comment to you was that rhetorical flamebait is not good for the site and you should take the hint to stop. Besides, the edit isn't even visible yet, so premature thanks ring hollow. –  SevenSidedDie Aug 13 '12 at 0:29
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Should this question go to an Economics forum? I once analysed this very same topic in a blog post/white paper. Will post an answer if the community agrees that this post deserves to be on the history Q&A site. –  Monster Truck Aug 13 '12 at 12:25
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closed as off topic by Louis Rhys, Drux, American Luke, Steven Drennon Feb 4 '13 at 2:19

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3 Answers

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The prototypical example I was thinking of when I wrote this was the Weimar Republic. (Decidedely not a developing country, but a very well-studied example of the principle). They got kind of a double-whammy at the end of WWI. The previous government under Kaiser Wilhelm had financed most of the war, acting on the assumption that reparations from the losers would pay it all back.

When they lost instead, the boot was on the other foot. The new Republic that took over found itself with all that internal war debt, plus its own huge bill for reparations to the victorious allies.

Germany's strategy for dealing with this was to print themselves more cash, use it to buy foriegn currency to repay the reparations, and let the ensuing inflation wither away their local debt to worthlessness.

enter image description here

Here's a commemortive coin from the era:

enter image description here

The text translates to:

On 1st November 1923 1 pound of bread cost 3 billion, 1 pound of meat: 36 billion, 1 glass of beer: 4 billion.

It was a fairly effective strategy, except of course that it impoverished the German people, destroyed thier economy, and dramatically strenghtened extremeist political parties.

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How does this relate to the original question? Wasn't the hyperinflation caused directly by external debt, not domestic? –  user357320 Aug 14 '12 at 16:34
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@user357320 - No. You could argue that it was caused indirectly by external debt. Directly, what caused it was that the currency wasn't backed by anything, and that they kept printing so much of it. Simple supply and demand theory indicates that if you drastically increase supply, demand (or the value of the object in question) drops. –  T.E.D. Aug 14 '12 at 17:47
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@TED But the original question ask about the results of tackling domestic debt with inflation. The difference between pre war Germany and for example the US in the 80s is that in the latter case all (or almost all) debt was in USD (i.e. their own currency). Trying to print your way out of external debt will certainly lead to a highly devalued currency like we saw in Germany and staggering inflation. The US could still do that today but most other nations cannot as they are straddled with with external debt (debt in another currency) that will not devalue with domestic inflation. –  user357320 Aug 14 '12 at 20:25
    
The US past 2010 is another good example... It's rapidly heading the same way, and the debt isn't decreasing one cent (in fact it's going up faster than the Federal Reserve can issue new money, despite all the "Quantitive Easing" and other money making plans coming out of the white house). –  jwenting Feb 2 '13 at 17:18
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Inflation is perceived as good for the debtor; the value/denomination of the debt remains constant while the value of the currency in which the debt is repaid is diminished. Since there is more money in circulation, there is more money with which to repay the debt.

What are the advantages? Inflation can ease the debt load. Rhode Island chose this as a strategy in the 1770's/80's in the US, which is why it was the last state to join the Union (RI was deeply in debt due to speculators, so they inflated their currency as a strategy ). Nobody wanted Rhode Island dollars

What are the disadvantages? Obviously inflation is bad for the lender. If inflation is rising and likely to continue to rise, then lendors must take this into account. That means that credit may be restricted, which may inhibit large and cooperative projects. Inflation is bad for anyone who is saving. Anyone with cash assets watches their value erode. Spend your money now because it will be worth less tomorrow. Again, this discourages investment in the future. This is the key to the italicized portion of your quote. If the leadership of a developing country inflates the domestic currency they can preserve their assets in foreign denominated currency, but ordinary citizens watch the value of their holdings dwindle away.

Mike Walden summarizes that inflation is bad because

  1. Unless you constantly work harder, the value of your wages and savings decline
  2. Businesses have trouble investing in new ventures or even just staying stable against competition
  3. Interest rates rise, making it difficult to borrow money.

(All of those assume that you don't have the opportunity to anticipate the inflation and shelter the value in foreign denominated currency, which the leaders do in the example you cite).

You restricted the question to domestic, but inflation theoretically causes other nations to change their exchange rates for your currency, which makes it more difficult to buy foreign goods. That can have significant consequences in a world where economies are coupled. (Petroleum in the 70's comes to mind). Developing countries also tend to be somewhat coupled - since most developing countries don't have the infrastructure to permit competitively priced domestic manufacture of industrial goods. (including things like farm equipment, medicine, petroleum, etc.)

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Welcome to History SE! +1 to get you started. Great to have you here. –  American Luke Oct 12 '12 at 17:19
    
Inflation is good for those who owe money, bad for those who own money. Since those making the laws are generally those who own money - inflation is generally seen as bad. –  none Feb 2 '13 at 20:41
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Since this question deals with economics, I think this blog entry by Prof Paul Krugman provides us with another good (counter-)example. He provides the example of France in the 1920s, and shows that the effect on a country with its own currency is not as severe as it is generally believed.

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