Is There a Government Debt Problem NOW With Biden Spending?
For an entire society or indeed for any corporation, a “productive debt” can be loosely defined as a debt that brings in more future purchasing power than what you borrow.
Lets suppose you lend me 1000$. For arguments sake, lets suppose the “basket of goods and services” that I consume costs 10$. You are lending me 1000$, which is equivalent to 100 baskets. You will charge interest on that debt. The interest is important, because it is like taxes: I MUST pay it, so it acts just like a tax: my “true” net disposable income is net of taxes AND net of interest payments.
If my income grows as much as the interest on that debt, then I can AT LEAST pay the interest on that debt without feeling it too much, and if I can “rollover” that debt eternally (re-borrow again when the principal payment is due, as government can do), then I won’t feel it all that much, even if there is obviously an opportunity cost to the interest payments: I could do other things with those interest payments if I didn’t have these payments to make.
Some debt is productive: I got into massive student debt for my honour’s bachelor’s degree in pure math, but this gave me options to make more income than I otherwise would have, by much more than the amount of debt + interest. It was a productive debt (but stressful to deal with, luckily I got more financing for my economics studies!).
The economics of public finance is actually quite involved and much more complex than many people realize, but the “government budget” ultimately boils down to expenditures and income, which are mostly this:
Government expenditures: interest on debt + all State spending.
Government income: mostly taxes.
Government debt must be looked at as the debt that the State owes to others than itself, relative to total income. I know this sounds funny, but debt held by the Central Bank and a few other State institutions is not “real” debt, because it is like you owing 1000$ to yourself. So what matters is “debt held by the public” relative to GDP, which for the USA is this:
The interest to pay on this debt has an upper bound that looks like this:
Interest payments on the debt are currently at an all-time low! Notice that the 1980s and 1990s of prosperity had significantly higher debt service ratios than what is observed now. This is because althought the LEVEL of debt has increased tremendously, the interest on that debt has dropped even more, so the net effect is a FALL in the debt service as percent of GDP, as seen in this graph. The issue is clearly NOT the current “debt service ratio.”
However there COULD be a broader issue: future economic growth could be entirely “eaten” by the debt service. If real economic growth goes to an average of slightly below 2% as projected (see below) and the real interest rate (nominal interest rate minus inflation) goes to about 1%, then more than half of all extra future income would go to paying the federal debt interest payments. This would pose a long term problem, as more than half of future income would go into a black hole of interest payments on debt that may not have been “productive” (not adding production capacity to the economy).
Currently, the REAL interest rate globally and in the USA is at most zero, and probably negative (inflation is above or equal to nominal yields in 75% of the global economy). There are too many funds looking to park in assets and not enough assets (i.e. the asset market is not “clearing”!). Inflation may well rise in the next few years as I wrote in my last post, while nominal interest rate may simply follow, leaving the real rate unchanged at about 0% or slightly negative… This would suggest that a persistent rise in the real interest rate is extremely unlikely, especially over several years. Moreover, the long run structural forces that are pulling the global real interest rate down will not go away: technology, demographics, growth in emerging markets, income and wealth inequality, etc.
Hence the real interest rate is unlikely to rise persistently above zero for any significant amount of time. Hence the “debt service” of government debt is NOT at risk of becoming a burden on real purchasing power any time soon.
One can certainly argue that government debt should be “productive” in pure economics terms: it should contribute to adding “production capacity” to the economy through human capital, incentives for innovation and efficiency, less negative externalities, mega infrastructure overhauls, etc. These are all “productive government debts.”
Sometimes going into debt is “less bad” than the alternatives. This is debateable to eternity, as we can’t go back and “try the covid crisis again” (or any other past shock) without extra government interventions and debt, but my personal take is that without massive State intervention as was done everywhere, there would have been a massive social breakdown and social tensions, with possible extreme scenarios that would indeed bring “growth and prosperity” to a grinding halt for a very long time. So. Based on that perspective, sometimes what may seem like “unproductive debt” is in fact the less bad of many bad options. Keeping society and democracy stable, peaceful and functional with one-shot massive “expensive” interventions can be seen as “productive debt”! Check out war-torn and conflict-ridden economies of LATAM or Africa and see the “prosperity” and standards of living they have!
But obviously, even just looking at the hard facts and data, the panic about government debt is STILL overblown: the debt service is NOT at risk of being a significant drain on future purchasing power any time soon… so I reiterate here, again as before, that current and future projected government debt levels for the USA and most industrialized economies do not seem to pose a significant problem with the current and medium-term projections for the real interest rate and inflation. So everybody just chill out about the government debt!
Pascal Bedard
pbeconomiste@gmail.com
