Low interest rates mean government revenues will grow faster than interest payments and help the debt burden. However, Poloz said the way governments spend this money during the fiscal expansion will affect the sustainability of the debt, creating a balancing act between investing in infrastructure and increasing the labour force, and printing money to create inflation.
Poloz said: “We have what looks like an inflationary policy today. But that’s only because it must counter a huge deflationary shock. It’s as if a bomb has gone off in our economy and a gigantic crater has opened up in front of us. The question is, how do we move forward?
“One way would be to walk down into the crater, cross it and walk up the other side. That’s a process that could take years and would amount to what we did during the Great Depression of the 1930s. Now, instead, central banks have filled the crater up with liquidity, meaning we can row our boats to the other side.
“At the moment, it takes an inflationary policy to counteract deflationary forces and the future depends on the balance between the two.”
Unsurprisingly, Poloz believes central banks will get this transition right but he warned there are multiple scenarios where things could go wrong. The biggest risk is politics; Governments have an incentive to inflate and, in turn, highly indebted households have an incentive to vote for it. Populism, therefore, carries a risk, especially as it’s often driven by widening imbalances in income distribution.
