Inflation and what it means to default on your debt
To summarize the entire upcoming article, defaulting on your debt means you are unable to pay a loan on time. The question that haunts nations is not what defaulting does, it’s, well, what happens next?
There is no one way to act after a nation defaults on its debts. The actions taken further will depend on how much the country owes in its own currency, how much it owes in other currencies, and how its people will deal with the possible upcoming inflation.
Borrowing is much simpler when you can control the inflation rate - as such, borrowing in your own currency is easiest when you have the power of the government. Usually a task left to the Central Bank* to decide, inflation rates can - in most cases - be controlled. By increasing inflation rates, interest rates will soon follow. This makes it much, much easier to pay back the money you had already borrowed. Furthermore, increasing rates of inflation make your products more competitive in the global market - other countries will not be able to compete with the low prices you are exporting at, as such, you will be able to export more products.
Although this all seems positive, high inflation rates may lead to massive losses to those who those who are saving their money. The money they have saved is quickly losing its value and often high inflation rates will result in more spending as people try to make use of the money they have before its value falls further. High inflation rates also increases costs, which may dampen economic growth. Yet, severe cases of inflation are relatively rare. Perhaps the most extreme case of inflation can be seen in Hungary through 1945-1956 where at one point it only took fifteen hours for prices to double (Hanke & Crus, 2012). This scenario is not likely to happen when a country cannot pay back its debt - many countries have successfully risen defaulting.
The issue is when a country owes money to other currencies. Yes, inflation will again come into play; however, this time it is much less an actor in the default as much as it is a consequence. The main effects are the same as what happens when individuals default on their debts to the bank - lower credit scores and higher interest rates for the next time they borrow.
Higher interest rates and notes on their track record are dealt with in countries also the same as individuals. A country that defaults needs to work on its growth, attempt to increase its national income**, and hopefully reach a point where its level of production is higher than its level debt. Countries may choose to increase taxes on certain things, cut government support on services, or find other ways to increase governmental income. Often, these policies will lead to short-term unemployment as the market restructures itself.
The last factor that comes into how a country may deal with defaulting is its people. As usual in economic downfalls, the people at the bottom of the ladder will often be more affected. When it comes to Lebanon, income inequality is not an easy subject. Almost 25 percent of GDP earnings go to the top 1 percent of the population. If inflation rates rise, the people who will be affected by a small rise in prices are those who are already affected by the current state of prices. In there stems the issue of how much of the population would be able to buy products at higher prices - and how the government will act to ensure low income households don’t fall off the map.
Notes for further understanding
* The Central Bank often raises and lowers the interest and inflation rates to help support the country’s current economic goals. Constant growth is not always a positive thing - growth often also leads to inflation. As such, the banks may raise interest rates to make sure people are saving instead of buying - or raise inflation rates for the same effect. These policies are known as inflationary policies - their opposite, and often what is used in situations of debt, are austerity policies, which include tax increases and cuts on spending, amongst other things.
** National income is the amount of money that a country actually earns - compared to GDP, or, Gross Domestic Product, which is the total amount a country produces.
Citations
Boesler, Matthew. “How 9 Countries Saw Inflation Explode Into Hyperinflation.” Business Insider, Business Insider, 14 Apr. 2014, www.businessinsider.com/worst-hyperinflation-episodes-in-history-2014-4#hungary-august-1945-july-1946-1.
“Countries Rarely Default on Their Debts.” The Economist, The Economist Newspaper, www.economist.com/finance-and-economics/2017/12/19/countries-rarely-default-on-their-debts.
“For the First Time, Lebanon Defaults on Its Debts.” The Economist, The Economist Newspaper, www.economist.com/middle-east-and-africa/2020/03/12/for-the-first-time-lebanon-defaults-on-its-debts.
Hanke, Steve H., and Nicholas Krus. “World Hyperinflation.” CATO - Working Paper, 15 Aug. 2015, https://www.cato.org/sites/cato.org/files/pubs/pdf/workingpaper-8_1.pdf.
McMahon, Tim, and Tim McMahon. “Which Is Better: High or Low Inflation?” InflationData.com, 26 May 2014, inflationdata.com/articles/2009/11/25/which-is-better-high-or-low-inflation/.
Rasmi, Adam. “Lebanon's Extreme Income Inequality Is Fueling Its Huge Protests.” Quartz, Quartz, 22 Oct. 2019, qz.com/1733225/lebanons-extreme-income-inequality-fuels-huge-protests/.
