Treasury Debt and Inflation Tax

Abstract

We calculate the implicit inflation tax borne by households due to their holdings of U.S. Treasury debt. Nominal assets lose value due to unexpected inflation. We calculate unexpected changes in current and future inflation and document households’ holdings of Treasury debt across the wealth distribution, accounting for direct and indirect holdings through financial intermediaries. Combining these two pieces of information, we calculate the implied inflation tax across household wealth groups over the past four decades.

Introduction

Households face an implicit inflation tax because they are net holders of nominal U.S. Treasury debt, which loses value when inflation unexpectedly increases. We consider households' holdings of Treasury debt across the wealth distribution, accounting for both directly held Treasury debt and debt held indirectly through financial intermediaries. We document households’ net holdings of Treasury debt and use changes in inflation and inflation expectations from the 1980s to the present to calculate the implied inflation tax across household wealth deciles over the past 40 years.

Unexpected inflation redistributes wealth from nominal lenders to nominal borrowers: When two parties enter a nominal contract, with one party paying another party a fixed dollar amount, an unexpected increase in the price level (inflation) lowers the contract’s real value. The U.S. government, the world’s largest single nominal borrower, sees the real value of its debt decrease with unexpected inflation, leaving debt holders to face an implicit inflation tax.

The majority of outstanding U.S. government debt is held by U.S. households. While households hold some Treasury debt directly, the vast majority of Treasury debt is held indirectly through intermediaries such as pension funds, mutual funds, and corporate equity, which in turn often partially comprise other intermediaries. To understand the importance of indirect Treasuries to household balance sheets, consider that, in the 1989 Survey of Consumer Finances, U.S. households held roughly $63 billion of direct Treasury debt. Direct holdings peaked at $180 billion in 2001 and had fallen to $80 billion by 2019. In contrast, indirect holdings of Treasuries totalled over $320 billion in 1983, increased to $620 billion by 2001, and grew to over $4 trillion in 2019.