Is It ever Good to Be In Debt?

Readers Question: What economic condition gives an advantage to those in debt?

Debt means that you both owe money to other people and therefore need to pay interest on the debt levels. The following economic conditions make it easier for those in debt.

High Inflation.

Inflation reduces the value of money. In periods of rapid inflation savers can see the value of their money rapidly decrease. But, debtors will also see the value of their debt effectively reduce. As prices go up, levels of debt become easier to pay back.

  • However, if interest rates remain higher than the inflation rate, inflation will not reduce the real cost of debt. In modern economies like the UK, inflation is usually lower than the interest rate. However, in periods of hyperinflation like Germany in the 1920s, the level of debt was soon wiped away.

Low Interest Rates

Low interest rates make the monthly mortgage repayments smaller. This is particularly important for those with mortgage debt. A small cut in interest rates can make it easier to meet mortgage interest payments.

However, the important thing is real interest rates. (Nominal interest rates – inflation). For example, if inflation is 1% and interest rates are 5%. The effective real interest rate is 4%. If inflation was 5% when interest rates were 5% it becomes much easier to pay back the debt.

However, low interest rates may not help people with credit card debt. E.g. a cut in the base rate may reduce the credit card interest rate from 18% to 17.5% (still very expensive)

Devaluation

If your debt was in dollars and you were getting paid in pound sterling. It would be easier to pay back the debt, because of the devaluation in the dollar.

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