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It is well known that debt can cause deflation, especially during crisis: to repay their debts agents sell their goods which causes a fall in prices.

But if there is no crisis and agents "have the time" to repay their debt, would it be possible to have the opposite mechanism, inflation: to repay their debts (and make their investments profitable) agents would sell their products for an higher price causing a raise in prices?

In the general case it seems difficult because this could destroy market shares if there is competition.

But in some cases I wonder if it could:

  • monopolys (especially state monopolys, and this would be a kind of hidden tax),
  • competition but with all competitors in debt so that all have to sell at higher prices to survive,
  • ...
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    $\begingroup$ I don't get it. Let us denote the current price by $p$. If the debtor can sell at $p' > p$ that implies that the demand side is there for such a sale. Without the debtor, why do the suppliers sell at $p$ and not at $p'$? Heavy competition would imply that the debtor cannot make a sale at $p'$ either because all demand is already fulfilled at $p$. $\endgroup$ – Giskard Jul 21 '15 at 22:20
  • $\begingroup$ Basically what I am saying is that if $D(p) = S(p)$ and $p' > p$ then $D(p') \leq S(p')$ so there is no room for the debtor to enter at a higher price. $\endgroup$ – Giskard Jul 21 '15 at 22:21
  • $\begingroup$ @denesp Thanks for your answer. It makes sense and I get your point. But if $p' = k p$ (with $k > 1$) then we could have $D(p') \geq \frac{1}{k} S(p')$. So if demand is not too elastic increasing the price by a factor could decrease the demand by less than this factor, making the operation profitable for the supplier. Please correct me if I'm wrong as my economics are quite rusty. :) $\endgroup$ – Pragmateek Jul 22 '15 at 11:42
  • $\begingroup$ Yes but what does this do with debt? It seems you can only gain from altering the price if the original price was suboptimal to begin with. $\endgroup$ – Giskard Jul 22 '15 at 12:06
  • $\begingroup$ The idea is that if you sell something for 100 and have 200 in debt if you don't want to go bankruptcy you could be tempted to sell it for 200 to repay your debt and be at least flat. If there is no competition and demand is not elastic the customers will accept to pay 200 because they have no choice. I can imagine a government which would be the only provider of water in a region: people have to pay for their daily water whatever the price. If the government have to repay debts it could be tempted to raise the price of water (hidden tax). $\endgroup$ – Pragmateek Jul 22 '15 at 15:42
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Yes it can.

If debt originates from the banking system, then it potentially has a side effect of money creation. Whether or not money is actually created when a bank loan is made depends on the banking system's regulatory framework, and the lending policies of its banks, and these can vary widely.

However if there is net excess of bank lending over bank loan repayment and loan default, then money creation is occurring, and the additional money can and indeed usually does, result in inflation.

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  • $\begingroup$ Thanks for your answer @Lumi. I would not have thought to this mechanism. Indeed it makes perfect sense, especially if the debtor is a country that will never repay its debt. $\endgroup$ – Pragmateek Jul 22 '15 at 11:49

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