Worried About Debt? Not so fast, say some economists

As the national debt swells, some economists are making a once heretical argument: The United States doesn’t need to worry so much about all of its red ink.

The Republican tax cuts of 2017 and this year’s Democratic spending proposals have reignited long-simmering concerns that the debt is getting too big. Annual deficits are expected to exceed $ 1,000 billion from 2022 and the Congressional Budget Office projects that debt will total 93% of gross domestic product by the end of the next decade.

Yet borrowing costs are still historically low, despite soaring deficits and debt in the years following the financial crisis. Debt as a percentage of GDP fell from 34% before the recession to 78% at the end of 2018. Treasury bill yields, meanwhile, fell from over 4% before the recession to 2.7%.

This suggests that investors are not worried about holding large volumes of credit.

In theory, a high level of debt should lead to higher interest rates. This is because investors will demand higher yields to compensate for the risk they take when the government borrows at unsustainable levels or because they fear such debt could trigger inflation. The need to finance such high debt levels also makes less money available for other investments.

In practice, investors are happy to continue lending to the United States in good times and bad, no matter how much they borrow. In 2009, for example, when the Obama administration’s stimulus efforts pushed federal deficits to nearly 10% of GDP, the highest since World War II, interest on 10-year Treasuries was remained below what they were before the recession.

Many Republicans have warned the United States is pushing itself to the brink of a budget crisis and urged Mr. Obama to limit spending. Economists have debated how much debt a country owes before curbing growth. In an article, Carmen Reinhart, professor of economics at Harvard University, and Kenneth Rogoff, former chief economist at the International Monetary Fund, found that countries with debt greater than 90% of GDP tended to have debts. slower growth rates.

Now, some prominent economists argue that America’s deficits don’t matter that much after all, and that it might not hurt to increase them in exchange for beneficial programs such as an infrastructure project.

“The debt levels we have in the United States are not catastrophic,” said Olivier Blanchard, an economist at the Peterson Institute for International Economics. “We can clearly afford more debt if there is a good reason to do so. There is no reason to panic.

Mr Blanchard, also a former chief economist at the IMF, spoke last month at the American Economic Association meeting, where he called on economists and policymakers to reconsider their views on debt.

The heart of Mr. Blanchard’s argument is that when the interest rate on government borrowing is lower than the rate of growth of the economy, debt financing should be sustainable.

Interest rates are likely to stay low for the next several years as the population ages. An aging population borrows and spends less and limits business investment, reducing borrowing costs. This suggests that the government will not be faced with an urgent need to reduce debt.

Blanchard refrains from arguing that the government should indulge in indiscriminate debt. The need to finance higher public debt could absorb investor capital that might otherwise be invested in promising private companies.

Mr. Rogoff himself is sympathetic. “The American position is very strong right now,” he said. “There is room.”

Some left-wing economists go even further, arguing for a new way of thinking about fiscal policy, known as modern monetary theory.

MMT argues that fiscal policymakers are not limited by their ability to find investors to buy bonds that finance deficits – because the US government can, if necessary, print its own currency to finance deficits or pay down debt. bond holders – but by the ability of the economy to support all the additional spending and jobs without shortages and inflation arise.

Rather than considering whether a new policy will increase the deficit, lawmakers should instead consider whether new spending could lead to higher inflation or create upheaval in the economy, said economist Stephanie Kelton, professor. at Stony Brook University and former Democrats’ chief economist. the Senate Budget Committee.

If the economy has the capacity to absorb this spending without increasing price pressures, policymakers do not need to “offset” this spending elsewhere, she said. If price pressures arise, policymakers may raise taxes or the Federal Reserve may raise interest rates.

“All we’re saying, the MMT approach, is just to point out that there is more space,” she said. “We could be richer as a nation if we weren’t so timid in using fiscal policy.”

So far, the increase in public debt has not led to sharp price increases. Inflation has remained at or below the Federal Reserve’s target for most of the past quarter century.

Yet many other economists are not ready to embrace these ideas.

Alan Auerbach, an economist at the University of California at Berkeley, says MMT’s view “is just plain silly” and could lead to unwanted or unexpected inflation.

Meanwhile, Greece and Italy are two recent examples of countries that appear to have reached thresholds where high debt leads to higher interest rates and economic hardship. The United States may also have such a threshold, but not yet seen.

Goldman Sachs Group Inc.

economists have found that countries with higher debt-to-GDP ratios as recessions approach have weaker fiscal responses, and therefore worse growth outcomes, although countries that issue debt in their own currencies , like the United States, seem less affected.

By continuing to run large deficits, says Marc Goldwein, senior vice-chairman of the Committee for a Responsible Federal Budget, the United States is slowing wage growth by crowding out private investment, increasing the amount of the budget spent on government. funding from the past and putting the country at low but increased risk of a future fiscal crisis.

Market interest rate signals can be misleading and dangerous. By blessing the United States with rates so low now, he says, the financial markets may well “give us a rope to hang on to.”

Write to David Harrison at [email protected] and Kate Davidson at [email protected]

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