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The Impact of Domestic Inflation to a Nation's Debt

April 13, 2012 | Comments: 0 | Views: 95

It is almost impossible for any country to avoid acquiring debts. This can even worsen whenever a country experiences severe trade deficits, which basically means that it is importing more than it is exporting. When the value of imports is far greater than the value of exports, then it is only natural that the economy of such country would come to a slump ultimately. This could be worsened further by the fact that such situation could force the government and the business sector to seek loans from outside of the country. When government goes out to borrow from other countries, its foreign debt could balloon to levels where it would not be able to repay them according to schedule.

The cycle, however, does not stop here. Ballooning national debt triggers inflation. When a national debt has become too big, the interest rates on these would definitely have an adverse impact on the domestic market. Domestic inflation could occur and would even become more serious during the process. One of the main reasons for this is that businesses become conscious of the instability of the national economy. Because of this, they would naturally tend to consider jacking up the prices of the commodities they are selling because of potential risks.

Inflation, on the other hand, only worsens the dependency of a country to foreign and domestic debts. When the market shrinks, not because the lack of consumers but because of the reduced buying power, businesses would naturally slacken. As a result, government may have to intervene through macro-economic solutions such as pump priming, which may include providing loans to private enterprises and declaring tax exemptions for them as well. Of course, this could greatly worsen the fiscal problems already experienced by a government. In order to avoid bankruptcy, it may turn to foreign and domestic loans again. This definitely serves further the spiraling downward trend of the national economy.

In order to stop the cycle, it would be necessary for a government to deal with the problem on two fronts. It would have to seek for more lenient treatment from creditors, including payment schedules that are advantageous to it. The arrangement could be similar to that of transacting for debt management solutions. It may actually have to face the creditors and attempt getting deals that would put it in an advantageous position without evading from its obligation. This may require some serious negotiations between the debtor and the creditor.

There would also be a need to introduce measures that would effectively control inflation. While a free market may be ideal for businesses, it is during a national debt crisis that governments should impose its will on the said sector. Policies on price controls should be formulated and implemented so that businesses could not arbitrarily increase the prices of their commodities. Governments may, however, be more biased when it comes to taxation. They may impose higher tax rates on imports while, at the same time, encourage local producers to step up and meet the demands of the market.

Jim Oneil is a writer with a special interest in debt issues and personal finance. He has written for small local newspapers in the past and now devotes part of his time writing about debt issues and other UK based financial products.

Source: EzineArticles
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