Public Debt: how much is too much?
Summary
TLDRThe COVID-19 pandemic has led to unprecedented levels of government borrowing, with the US alone borrowing $3 trillion in Q2 2020. Historically, high debt post-war periods like after Napoleonic wars and WWII were managed, and recent economic thinking suggests that higher debt levels may be sustainable, especially with low-interest rates and growing economies. However, the sustainability of such debt is uncertain, and the pandemic's impact on public debt will be a significant legacy, with risks including potential rises in interest rates.
Takeaways
- 🌐 The COVID-19 pandemic has led to governments worldwide borrowing and spending at unprecedented rates.
- 💵 Between April and June, the United States alone borrowed a record $3 trillion, the most ever in a single quarter.
- 📈 The rise in public debt has been dramatic and unlike anything seen in recent history.
- 🏛️ Historically, governments have borrowed heavily to finance wars and to stabilize economies.
- 💼 To finance spending, governments issue bonds, which are essentially IOUs repaid over time with interest.
- 🌍 Government bonds are considered safe assets and are bought by a variety of investors, including foreign governments.
- 📉 After World War II, governments were cautious about borrowing due to high debts, but this changed with the global financial crisis.
- 📊 The economic downturn following the financial crisis led to a rise in public debt in both rich and emerging economies.
- 💡 New economic thinking, influenced by Olivier Blanchard, suggests that governments can sustain higher levels of debt than previously thought.
- 🌟 As long as GDP growth outpaces debt interest accumulation, countries can effectively grow out of debt without fiscal strain.
- 🚨 Despite the potential for higher debt sustainability, there are risks, including the possibility of rising interest rates.
Q & A
What was the unprecedented rate of borrowing by the U.S. between April and June?
-Between April and June, the United States borrowed $3 trillion, which is the largest amount borrowed in a single quarter since records began.
What is the historical context of public debt levels after major conflicts?
-Historically, after the Napoleonic wars in 1815, Britain's debt was 164% of GDP, and after World War II, it was even higher at 259% of GDP.
Why have governments traditionally issued bonds?
-Governments have traditionally issued bonds to raise money, which are essentially IOUs repaid over a fixed term with interest, depending on the bond's length.
Who are the typical buyers of government bonds?
-Government bonds are bought by various investors including pension funds, hedge funds, banks, individual investors, a country's own central bank, local government, and foreign governments.
Why are U.S. government bonds considered safe assets?
-U.S. government bonds are considered safe assets because the U.S. government is typically reliable in repaying its debts, ensuring investors get their money back.
What was the impact of the 1970s borrowing on inflation according to the script?
-In the 1970s, high levels of government borrowing were blamed for high inflation, as the additional money in the economy was too much for it to absorb, leading to increased prices.
How did the global financial crisis affect public debt levels in rich and emerging economies?
-In the decade following the global financial crisis, public debt in rich countries rose from 74% to around 105% of GDP, and in emerging economies it rose from roughly 35% to 48% of GDP.
What was the lesson learned from austerity measures following the financial crisis?
-The lesson learned was that austerity in a time of economic weakness can hurt economies so much that it doesn't do any good, as the economy becomes too weak to generate sufficient tax revenues.
What did Olivier Blanchard argue in his 2019 speech about government borrowing?
-Olivier Blanchard argued that governments could borrow far more than previously believed, as long as GDP growth outpaces debt accumulation and additional borrowing is controlled.
How has the coronavirus pandemic affected government borrowing?
-The coronavirus pandemic led to the greatest exercise in public borrowing for generations, with governments borrowing unprecedented amounts to support their economies.
What are the risks associated with the current low interest rates on government bonds?
-The risks include the possibility that interest rates could rise again, which would put countries with high debt in trouble. Additionally, the cause of low interest rates is not entirely understood, which introduces uncertainty about their future.
Outlines
📈 Unprecedented Government Borrowing Amidst COVID-19
The COVID-19 pandemic has led to governments borrowing and spending at unprecedented rates. The United States alone borrowed $3 trillion from April to June, the highest in a single quarter on record. Public debt has risen dramatically, contrasting with past economic wisdom that warned against high borrowing. Newer economic thinking suggests that higher levels of debt may now be sustainable. Historically, governments have borrowed for various reasons, primarily to fund wars, but in the last century, to also stabilize the economy. Bonds are issued to investors, acting as IOUs with repayment over a set term at an interest rate dependent on the bond's length. The attractiveness of these bonds to investors is based on the country's creditworthiness, with government bonds being a safe asset. These bonds are bought by various entities, including pension funds, hedge funds, banks, individual investors, central banks, local governments, and foreign governments. The willingness of governments to issue bonds and increase public debt has fluctuated over time. After WWII, governments were cautious about borrowing due to high debts, but this changed with the 1970s' inflation, which was blamed on excessive borrowing. This led to a shift in thinking about debt and borrowing as a macroeconomic tool, which was further impacted by the global financial crisis. The crisis increased public debt significantly in both rich and emerging economies, leading to austerity measures that were later deemed ineffective due to economic weakness.
📉 The Economic Implications of Rising Public Debt
The speech by former IMF chief economist Olivier Blanchard in 2019 suggested that governments could borrow more than previously thought, as interest rates on government bonds have been falling, making borrowing cheap. This, coupled with economic growth, has allowed countries to grow their way out of debt at no fiscal cost, provided GDP growth outpaces debt interest accumulation. However, the COVID-19 pandemic has led to a significant increase in public borrowing, with governments facing the challenge of borrowing to support their economies. The ease of borrowing varies between rich and poor countries, with the latter facing higher interest rates and less access to foreign markets. The low interest rates, driven by factors such as an aging population and fear of financial instability, have kept rates down, but the uncertainty of their continuation poses a risk. A sudden increase in interest rates could put heavily indebted countries in trouble. Despite these risks, many countries have had no choice but to continue borrowing during the pandemic, as cutting deficit spending could inflict lasting damage. The long-term impact and sustainability of this debt are uncertain, but it will undoubtedly be a significant legacy of the pandemic.
Mindmap
Keywords
💡Covid-19 pandemic
💡Public debt
💡Economists
💡Debt sustainability
💡Government bonds
💡Creditworthiness
💡Inflation
💡Austerity
💡Interest rates
💡GDP growth
💡Recession
Highlights
Covid-19 pandemic has led to unprecedented levels of government borrowing.
Public debt has risen dramatically, unlike anything seen in recent history.
Economists have traditionally warned against high levels of borrowing.
New thinking suggests that higher levels of debt might now be sustainable.
The shift in consensus on debt sustainability is causing some to be nervous.
Governments have been borrowing to finance spending for centuries.
Britain's debt was 164% of GDP after the Napoleonic wars in 1815.
Post-WWII, Britain's debt was at 259% of GDP.
Governments primarily borrow to fight wars and stabilize economies.
Governments issue bonds to investors as a way to raise money.
Government bonds are considered safe assets with a high likelihood of repayment.
Bonds can be traded in the market, reflecting market views on government creditworthiness.
Government bonds are bought by various investors, including foreign governments.
China and Japan are the largest foreign holders of America's public debt.
Governments' willingness to issue bonds and increase public debt has fluctuated over time.
High inflation in the 1970s was blamed on excessive government borrowing.
The global financial crisis led to a significant increase in public debt.
Austerity measures following the financial crisis were largely ineffective.
Olivier Blanchard argued in 2019 that governments could borrow more than previously thought.
Low interest rates on government bonds have made borrowing cheaper.
As long as GDP grows faster than debt interest, a country can grow out of debt.
The Covid-19 pandemic has led to the greatest exercise in public borrowing for generations.
Not all countries can borrow their way through the pandemic due to varying interest rates.
The risk of rising interest rates poses a threat to countries with high debt.
The reasons behind low interest rates are uncertain, which introduces risk.
Many countries have no choice but to continue borrowing amidst the pandemic.
The debt accumulated during the pandemic will be one of its most significant legacies.
Transcripts
The covid-19 pandemic has forced governments around the world...
...to borrow and spend at an almost unprecedented rate
Between April and June, America alone has borrowed $3trn...
...the largest amount borrowed in a single quarter since records began
The rise in public debt has been...
...unlike anything we’ve seen in recent history
In the past, economists have warned against...
...high levels of borrowing
But new thinking suggests much higher levels of debt...
...might now be sustainable
The fact that there’s been such a dramatic change in the consensus...
...makes some people nervous
How much of a cause for concern...
...should the world’s rising public debt be?
Governments have borrowed to finance their spending...
...for hundreds of years
At the end of the Napoleonic wars in 1815...
...Britain’s debt was 164% of GDP
And after the second world war it was even higher...
...at 259% of GDP
Historically, governments have borrowed for a few main reasons...
...probably the biggest one was to fight wars
But in the past 100 years or so...
...governments have increasingly used their debt...
...as a way to try to keep the economy on track
To raise money, governments issue bonds to investors
These are in effect IOUs that are repaid over a fixed term...
...with interest at a rate that depends on the length of the bond
How desirable these bonds are to investors...
...depends on the country’s creditworthiness
They tend to be very safe assets...
...with governments you can usually count on getting your money back
Once a bond has been sold by the government out into the market...
...it can be swapped and traded as many times...
...as people care to
And that gives you a sense of how markets view...
...the creditworthiness of the government
Government bonds are bought by many different investors, including...
...pension funds, hedge funds, banks and individual investors...
...as well as a country’s own central bank and local government
Foreign governments also buy bonds
The biggest foreign holders of America’s public debt...
...are China and Japan
If you have a safe asset that everyone will accept...
...like US government bonds...
...you can sell those bonds in a crisis, get dollars...
...and then use that to make sure you don’t get into trouble
So there’s quite a lot of potential buyers out there for government bonds...
...and really they could end up all over the world
Governments’ willingness to issue bonds, and increase public debt...
...has changed over time
After the sky-high debts of the second world war...
...many governments were wary of going further into the red
But they continued to borrow...
...and in the 1970s, this was blamed for high inflation
A lot of economists spoke to governments and said...
...the reason you’re facing these high rates of inflation...
...is because you’re borrowing so much
It’s adding too much money into the economy...
...for the economy to easily absorb...
...and it’s pushing up prices
That really ushered in a sea change...
...in the way that governments think about debt...
...and so the use of borrowing as a macroeconomic tool...
...slowly petered out...
...until we got to the global financial crisis
Now it’s official, we are in a recession
Major financial institutions have teetered on the edge of collapse...
...and some have failed
In the rich world, the financial crisis pushed public debt...
...from 74% to around 105% in the decade following the financial crisis
And in emerging economies it rose...
...from roughly 35% to 48% of GDP
This ballooning debt caused political panic...
...with some governments pursuing strict austerity...
...to try to bring their budget deficits down...
...during the decade that followed
But it didn’t go entirely to plan
By about 2014 the lessons of that experiment...
...began to be pretty clear
And what we learned was austerity in a time of economic weakness...
...hurts economies so much that it basically doesn’t do any good
The economy becomes so weak...
...that you’re not earning enough in tax revenues to make it worth it
These problems with austerity led to new thinking
In 2019 former IMF chief economist, Olivier Blanchard...
...gave a game-changing speech
He argued governments could borrow...
...far more than previously believed
I think the fact that there’s been...
...such a dramatic change in the consensus...
...makes some people nervous
But at the same time it wasn’t a rash decision they made...
...it was heavily influenced by what was going on in the world around them
Blanchard observed interest rates on government bonds have been falling...
...making it cheap for some governments to borrow money
At the same time, the economy was growing
Take America: the rate of nominal GDP growth...
...which is GDP before it has been adjusted for inflation...
...has generally been higher than interest rates for the past 30 years
This matters, because as long as GDP is growing...
...faster than the country’s debt is accumulating interest...
...and governments keep additional borrowing in check...
...then a nation can effectively grow its way out of debt...
...at no fiscal cost
Mathematically, it’s a very straightforward point
But when you’re explaining this to governments...
...and saying, “This is how it goes”...
...that ends up being quite a powerful thing
Not even a year after Blanchard gave his speech...
...coronavirus emerged in Wuhan...
...and the greatest exercise in public borrowing for generations began
Government borrowing hit a record £55bn
Ballooning public debt
Around $300bn or 16% of GDP
But not every country can borrow its way through the pandemic
Almost every government has found it easier to borrow now...
...than it was 30 or 40 years ago
But the difference between a rich country and a poorer country...
...which doesn’t have a long record of borrowing on foreign markets...
...those places can’t get the same interest rates
It is a source of significant inequality...
...in terms of how countries face this pandemic...
...that some places can borrow almost as much as they want...
...to support their economies and others can’t
Borrowing on this scale is not without risk for anyone
You owe us a lot of money
What?
As there is always the threat that interest rates could rise again
Economists aren’t entirely sure...
...why these rates have been low for so long
In general, interest rates on mortgages, government bonds...
...or savings accounts are driven by demand
If the desire to save is high, then interest rates will be low...
...as banks, or governments issuing bonds...
...don’t have to tempt investors with favourable rates
There are several factors driving the desire to save...
...which might be keeping interest rates down
The ageing population might be one cause...
...as people tend to save for retirement...
...and pension funds buy government bonds
And fear of global financial instability may also play a part...
...causing investors to seek safe assets like bonds
We can’t be completely sure why exactly it’s happened...
...and that matters because if you can’t be certain why it happened...
...in the first place...
...you can’t say for sure that it’s not going to reverse itself...
...at some point in the future, which would be a big deal
You know if interest rates suddenly soared...
...then all the countries that had accumulated a lot of debt...
...would suddenly be in very big trouble
Despite these risks, the pandemic has left many countries with no option...
...but to keep borrowing
To cut deficit spending now...
...while the global economy is still crippled by the pandemic...
...would inflict lasting damage
But how much, and how long...
...countries can continue to borrow is unclear
And the colossal debt built up in the past six months...
...will be one of the greatest legacies of the pandemic
I’m Ryan Avent, economics columnist at The Economist
We’ve written a series of articles that cover the basics...
...on a range of economic topics...
...and how the latest thinking about them is evolving
You can read more at the link opposite
Thank you for watching
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