Worry About Debt? Not So Fast, Some Economists Say
As the national debt rises, some economists are making a once-heretical argument: the U.S. needn’t be so worried about all of its red ink.
The 2017 Republican tax cuts and this year’s Democratic spending proposals have reignited long-simmering worries that the debt is getting too big. Annual deficits are set to top $1 trillion starting in 2022 and the Congressional Budget Office projects debt will total 93% of gross domestic product by the end of the next decade.
Yet borrowing costs are still historically low, despite a surge in deficits and debt in the years following the financial crisis. Debt as a share of GDP rose from 34% before the recession, to 78% at the end of 2018. Treasury yields, on the other hand, have fallen from over 4% before the recession to 2.7%.
That suggests investors aren’t worried about holding large volumes of credit.
In theory, high debt levels should cause interest rates to rise. That’s because investors will demand higher returns to compensate for the risk they take on when the government borrows at unsustainable levels or because they worry that so much debt could trigger inflation. The need to finance such high levels of debt also makes less money available for other investments.
In practice, investors are happy to keep lending to the U.S. in good times and bad, regardless of how much it borrows. In 2009, for instance, when the Obama administration’s stimulus efforts sent federal deficits rising to almost 10% of GDP, the highest since World War II, the interest on 10-year Treasury securities remained below where it had been before the recession.
Many Republicans warned the U.S. was pushing itself to the brink of a fiscal crisis and pressed Mr. Obama to rein in spending. Economists debated how much debt a nation could hold before it crimped growth. In one paper, Harvard University economics professor Carmen Reinhart and Kenneth Rogoff, a former chief economist at the International Monetary Fund, found that countries with debt loads greater than 90% of GDP tended to have slower growth rates.
Now, some prominent economists say U.S. deficits don’t matter so much after all, and it might not hurt to expand them in return for beneficial programs such as an infrastructure project.
“The levels of debt we have in the U.S. are not catastrophic,” said Olivier Blanchard, an economist at the Peterson Institute for International Economics. “We clearly can afford more debt if there is a good reason to do it. There’s no reason to panic.”
Mr. Blanchard, also a former IMF chief economist, delivered a lecture at last month’s meeting of the American Economic Association where he called on economists and policymakers to reconsider their views on debt.
The crux of Mr. Blanchard’s argument is that when the interest rate on government borrowing is below the growth rate of the economy, financing the debt should be sustainable.
Interest rates will likely remain low in the coming years as the population ages. An aging population borrows and spends less and limits how much firms invest, holding down borrowing costs. That suggests the government will not be faced with an urgent need to shrink the debt.
Mr. Blanchard stops short of arguing that the government should run up its debt indiscriminately. The need to finance higher government debt loads could soak up capital from investors that might otherwise be invested in promising private ventures.
Mr. Rogoff himself is sympathetic. “The U.S. position is very strong at the moment,” he said. “There’s room.”
Some left-wing economists go even further by arguing for a new way of thinking about fiscal policy, known as Modern Monetary Theory.
MMT argues that fiscal policy makers are not constrained by their ability to find investors to buy bonds that finance deficits — because the U.S. government can, if necessary, print its own currency to finance deficits or repay bondholders — but by the economy’s ability to support all the additional spending and jobs without shortages and inflation cropping up.
Rather than looking at whether a new policy will add to the deficit, lawmakers should instead consider whether new spending could lead to higher inflation or create dislocation in the economy, said economist Stephanie Kelton, a Stony Brook University professor and former chief economist for Democrats on the Senate Budget Committee.
If the economy has the ability to absorb that spending without boosting price pressures, there’s no need for policy makers to “offset” that spending elsewhere, she said. If price pressures do crop up, policy makers can raise taxes or the Federal Reserve can raise interest rates.
“All we’re saying, the MMT approach, is just to point out that there’s more space,” she said. “We could be richer as a nation if we weren’t so timid in the use of fiscal policy.”
So far the runup in government debt has not led to steep price increases. Inflation has stayed at or below the Federal Reserve’s target for most of the past quarter century.
Still, many other economists aren’t ready to embrace these ideas.
Alan Auerbach, an economist at the University of California at Berkeley, says the MMT view “is just silly” and could lead to unwanted or unexpected inflation.
Meantime, Greece and Italy are two recent examples of countries that appear to have hit thresholds where high debt loads lead to higher interest rates and economic pain. The U.S. may have such a threshold too, just not yet seen.
Goldman Sachs Group Inc. economists found that countries with higher debt-to-GDP ratios heading into recessions have smaller fiscal responses, and subsequently worse growth outcomes, though countries that issue debt in their own currency — such as the U.S. — appear to be less affected.
By continuing to run large deficits, says Marc Goldwein, senior vice president at the Committee for a Responsible Federal Budget, the U.S. is slowing wage growth by crowding out private investment, increasing the amount of the budget dedicated to financing the past and putting the country at a small but increased risk of a future fiscal crisis.
Market interest rate signals can be misleading and dangerous. By blessing the U.S. with such low rates now, he says, financial markets just might be “giving us the rope with which to hang ourselves.”
Source: Dow Jones