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

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.