Why rising asset prices reduce public debt ratios

I n this Flash we analyse a poorly understood mechanism: the role of asset prices (equities, real estate, etc.) in the public debt ratio dynamics. The public debt ratio declines: Of course , if there is a primary fiscal surplus; If the long-term interest rate is lower than nominal potential growth; If there is inflation (in goods and services prices), which generates inflationary taxation of money balances; But also if asset prices rise; this mechanism must be understood: if asset prices rise, at portfolio equilibrium, households must hold more money (to bring the weight of money in wealth back to the desired level); demand for money (investment money, not transaction money) is therefore increased, which makes it possible to increase the money supply (monetisation of the fiscal deficit) and to reduce the public debt ratio. A rise in asset prices, combined with an increase in demand for investment money, therefore reduces the public debt ratio, which may lead governments to accept rising asset prices.