Public Debt: how much is too much?

The Economist

8 Sept 202009:01

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

00:00

📈 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.

05:03

📉 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

The Covid-19 pandemic refers to the global outbreak of the novel coronavirus disease that began in late 2019. It has led to widespread health, social, and economic disruptions. In the context of the video, the pandemic has forced governments to borrow and spend at unprecedented rates to mitigate the economic impacts, leading to a significant rise in public debt.

💡Public debt

Public debt is the total amount of money that a government owes to its creditors. It is often used to finance public spending when tax revenues are insufficient. The video discusses how the pandemic has led to a dramatic increase in public debt, with America alone borrowing $3 trillion between April and June, the largest amount since records began.

💡Economists

Economists are experts in the social science of economics, concerned with the production, distribution, and consumption of goods and services. In the video, economists have traditionally warned against high levels of borrowing, but recent thinking suggests that much higher levels of debt might now be sustainable, reflecting a shift in economic consensus.

💡Debt sustainability

Debt sustainability refers to a country's ability to meet its debt obligations without incurring high costs or requiring bailouts. The video discusses how new thinking suggests that higher levels of debt might be sustainable, especially if a country's nominal GDP growth is higher than its interest rates, allowing it to 'grow its way out of debt'.

💡Government bonds

Government bonds are debt securities issued by governments to raise capital. They are effectively IOUs that are repaid over a fixed term with interest. The video explains that these bonds are considered safe assets, and their desirability to investors depends on the country's creditworthiness.

💡Creditworthiness

Creditworthiness is the ability of a borrower to repay loans. It is a measure of trust in the credit market. In the video, the concept is used to explain how desirable a country's bonds are to investors, which in turn affects the interest rates at which governments can borrow.

💡Inflation

Inflation is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. The video mentions that in the 1970s, high levels of government borrowing were blamed for causing high inflation by adding too much money into the economy.

💡Austerity

Austerity refers to a government's policy of reducing its budget deficit through spending cuts, tax increases, or a combination of both. The video discusses how some governments pursued austerity measures after the global financial crisis to reduce their budget deficits, but these measures were found to be counterproductive during economic weakness.

💡Interest rates

Interest rates are the cost of borrowing money and the return on saving or investing money. The video notes that interest rates on government bonds have been falling, making it cheaper for some governments to borrow money, which is a key factor in the sustainability of higher levels of debt.

💡GDP growth

GDP growth refers to the increase in the market value of all the finished goods and services produced within a country's borders in a specific time period. The video explains that as long as a country's nominal GDP growth is higher than its debt interest, it can effectively grow its way out of debt.

💡Recession

A recession is a significant decline in economic activity that lasts more than a few months. The video mentions that the global financial crisis pushed many countries into recession, leading to an increase in public debt as governments tried to stimulate their economies.

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.