The Global Distributive Impact of the US Inflation Shock

We study the global distributive consequences of the "Great Reflation." The conventional wisdom holds that the increases in interest rates resulting from high inflation in the United States will have a negative impact on the rest of the world (and developing countries in particular) due to the reversal of capital flows and higher financing costs. We show that the standard view fails to take into account an important countervailing force: the effect of higher US inflation on the changing real value of nominal US dollar assets and liabilities across countries. Decades of low inflation led to widespread use of dollar-denominated financial instruments with fixed interest rates and long maturities. Unanticipated inflation in the US diminishes the real value of dollar-denominated sovereign debt, both in the US and abroad. For sovereigns other than the US, the gains are equivalent to a debt relief of about $100 billion. On the other hand, the US government gains nearly $2 trillion on its debt and cash liabilities, of which fully one-quarter (over $500 billion) is paid by non-residents.