castor avec une brouette d'argent devant l'assemblée

It is often said that inflation is good for public finances, with essentially two arguments. The first is that a rise in consumer prices mechanically raises VAT revenues; a rise in wages mechanically raises the social contributions paid; and so on for each levy raised on a nominal base. The second argument is that government debt is fixed in euros (€2800bn in France at end-2021): dividing this debt by a rising nominal GDP, the ratio decreases. In other words, it becomes easier to repay a debt that has not changed.

These two arguments are not wrong, but they forget important elements, notably the origin of inflation. In the current context, the money we pay to oil and gas foreign suppliers will sooner or later run out of government coffers.

Primary balance

Let's start by looking at the impact of inflation on the primary balance, i.e. excluding interest payments. This balance is usually measured as a proportion of nominal GDP. At first sight, inflation increases revenues, expenditures and the denominator (GDP) in parallel, so that the ratio of the balance to GDP should not depend on prices. Why, then, do we have in mind that rising prices will reduce the deficit in the short run? The main reason is the only gradual indexation of expenditure.

When prices rise, tax revenues can increase faster than government expenditure. For example, if consumer prices rise, VAT revenues mechanically increase for a given volume of consumption. Similarly, rising wages increase the social security contributions collected, while rising corporate profits lead to additional corporate income tax revenues.


Some public expenditure is also indexed to prices: pensions, family allowances, housing allowances, minimum income, etc. are indexed within less than a year in France. Each additional percentage point of inflation automatically increases these social expenditures by almost €5 billion. However, the indexation periods for other expenditure are variable, for example for procurement contracts, or for civil service salaries. In the short term, inflation can therefore reduce the public deficit, but the effect will quickly dissipate.

However, so far we have considered all quantities as given: the tax bases (consumption, income) as well as expenditure are fixed in real terms. In fact, all of this also varies!

On the expenditure side, the government can decide on exceptional expenditure to protect the purchasing power of households and limit the impact of the increase in input costs for companies. In France, the inflation allowance, the exceptional reinforcement of the energy voucher, the tariff shields on gas and electricity and the aid granted to the most exposed companies are all discretionary expenditure caused by inflation and which increase the deficit (Table 1).

Table 1. Discretionary measures decided by the French government, Dec. 2021 to May 2022

Lump sum transfers to households

Tariff shields

Aid to businesses

Inflation allowance: €100 paid at the end of 2021 and beginning of 2022 to 38 million individuals.

Exceptional energy voucher: €100 paid to 5.8 million households in December 2021.

Exceptional back-to-school aid.

Early revaluation of pensions and benefits.

Revaluation of the civil service point

Electricity: increase in the regulated tariff limited to 4% in February 2022, extension of the regulated quota of nuclear power extended by EDF to retailers (ARENH).

Gas: freezing of the regulated tariff from October 2021.

Fuel: 15c€/l exl. VAT discount at the pump from April 2022.


Subsidies for energy-intensive companies.


Source: Budgetary documents.

On the revenue side, tax bases in real terms move in a direction that depends on the origin of inflation. If, as was the case at the beginning of the economic recovery after the Covid crisis, inflation is linked to a rapid recovery in demand, then the tax bases increase not only in value but also in real terms. But if, as now, inflation is driven by higher prices for imported energy and raw materials, then prices rise but GDP, employment and consumption are negatively affected (the economy becomes poorer). Table 2 compares the effect of a positive shock on world demand to that of an increase in oil prices, according to the Mesange macroeconomic model. In both cases, prices increase. But the primary balance improves in the former case while it deteriorates in the latter, due to a decrease in all tax bases in real terms.

Table 2. Impact of a demand shock and a supply shock on GDP, prices and the primary balance


Year 1

Year 2

Year 10

1% increase in foreign demand for France

 Real GDP




Real disposable income of households




Consumer price index




Production price index




Primary balance/GDP




Oil price increase of $25/barrel

Real GDP




Real disposable income of households




Consumer price index




Production price index




Primary balance/GDP




Source: Mésange Model.

What inflation?

Table 2 also shows that, in the event of an increase in oil prices, consumer prices rise faster than producer prices, whereas the opposite is true after a demand shock. As detailed by Fipeco (2021) and the OFCE (2022), the tax bases (income tax, social contributions, production taxes, etc.) essentially follow the GDP deflator (price of a unit of GDP), while public spending follows the consumption deflator (price of a unit of consumption). When the GDP deflator grows slower than the consumption deflator, revenues grow less than expenditures and the deficit increases. This effect can be hidden in the short term by indexation lags, but from the second year onwards it becomes clear.

Today, inflation is largely of imported origin, so the above mechanism applies. However, dynamic tax revenues are expected in 2022 due to:

  • Rising corporate profits in 2021, driven by a very strong recovery in the economy. The corporate tax collected in 2022 depends largely on profits in 2021.
  • The strong dynamism of employment in 2021: at the end of March 2022, according to INSEE, employment was 2.8% above its end-2019 level, while GDP was only 0.3% above its pre-crisis level. The greater dynamism of the wage bill than of nominal GDP yields higher revenues from tax and social security contributions.
  • The decline in the savings rate from an exceptionally high level in 2020 and, to a lesser extent, in 2021. The VAT base therefore grows both through a price effect and a volume effect.

It should be noted that these three effects, which are linked to the recovery from the pandemic, are temporary: the savings rate cannot decrease every year; the exceptional economic recovery of 2021 will not be repeated any time soon; the labour share could gradually return to its long-term value. Conversely, the increase in import prices could well be permanent, which will induce a volume effect (lower GDP, lower employment, lower consumption in real terms) and a value effect (lower increase in the value produced compared to the value consumed), both of which are unfavourable to the primary balance.


The speed of accumulation of public debt depends fundamentally on two factors:

  • The primary balance (see above)
  • The difference between the interest rate and the growth rate, the so-called "r-g", multiplied by the debt level.

The apparent nominal interest rate on public debt - the interest payments divided by the amount of debt the year before - was 1.5% in 2021 for France. One tenth of the debt is indexed to inflation, so that each additional percentage point of inflation leads to an immediate increase in the apparent rate of about 0.1 percentage point (and therefore a cost of €2.5bn). 30% of these securities are indexed to French inflation and 70% to Eurozone inflation. The rest of the debt is fixed rate. As the average maturity is 8.2 years (see Copin and Dalbard, 2022), the rise in interest rates following the rise in inflation takes time to be passed on in the cost of the debt (graph).

Graph : impact of a 1pp interest rate increase on government interest payments in France

Source: Finance Law for 2022, programme n°117

Source: Finance Law for 2022, programme n°117

To make it simple, on the one hand there is an immediate effect, for the 1/10th of the debt which is indexed to inflation, and for the rest of the debt there is a progressive effect linked to the rise in market interest rates, as the debt is refinanced. Because inflation has risen much faster than interest rates so far, the former effect dominates in the short term. In the longer term, however, it is the rise in interest rates that dominates.

Such an increase in the debt burden is not a problem if nominal GDP increases by the same amount. However, the inflation to be taken into account is that of the GDP deflator, while the rise in the nominal interest rate is based on the rise in consumer prices (cf. the European Central Bank's objective). And of course, if real GDP is negatively affected by the energy shock (see Table 2), debt accumulates all the faster.


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>> Version française : Finances publiques : une inflation qui rapporte ?

>> All posts by Agnès Bénassy-Quéré, chief economist - French Treasury