Just how much debt is too much for any country to safely issue?

Livemint     2nd December 2020     Save    
QEP Pocket Notes

Context: Rising debt is fine so long as it protects the economic capacity of spenders and Public spending; however, must be sensible, not based on infinite spending.

Issues with rising debt:

  • Rising cumulative debt levels: Government expenditure has reached 15-20% of the Gross Domestic Product (GDP) in many countries, and the debt levels have reached the level during World War II.
  • Low levels of interest: Newly issued sovereign debt is now paying negative interest rates, additional borrowing stands to reduce interest expenses even more.
  • Adverse impact on the investors’ confidence: Investors will buy that new debt only if they are confident that the government can repay all its debt from its prospective revenues.

Arguments in favour of excessive government borrowings: Favoured by the Modern Monetary Theory (MMT).

  • With ultra-low interest rates, borrowing should be cheap: the central bank could print money to pay off the maturing debt.
  • No risk of inflation: as long as there is sizeable unemployment.

Arguments against the MMT:

  • Inadequate in the medium term: When the citizens already have money to spare, they will save their money in the banks impacting the interest rates. (banks may not increase their reserve after a limit)
    • This approach does not allow the government to borrow any more than it could have by financing directly.
  • Additional borrowing is also limited by the following two factors:
    • If the funds raised are invested in high-return infrastructure projects, additional future revenues are dependent on the efficiency of the projects.
    • If the money is spent on the poor and vulnerable households, the limit becomes explicit.

Way Forward:

  • Reduce the stock of existing debt: to create room for new issuance; this can be done by :
    • To default on old obligations; ()unthinkable by advanced economies)
    • Allow for high inflation: which would erode the stock of debt denominated in current dollars vis-à-vis future tax revenues; new debt holder will then demand high interests.

Conclusion: While on the one hand, total austerity is also not desired, but public spending should target to protect the economic capacity of households and firms during the pandemic.

QEP Pocket Notes