Payback is a Bitch
Capital Thinking • Issue #698 • View online
This is a draft of an oped. I got done and saw it's 1500 words, so I'm posting it for your enjoyment rather than go through a painful 600 word diet. Diet later. Maybe.
Last week, the U.S. passed a milestone — US federal debt in private hands exceeded 100% of GDP. But does all this debt matter, or is worrying about debt passé?
DEBT MATTERS
John H. Cochrane | The Grumpy Economist:
This debate has been going on among economists for a while. One does not need to go to the incoherence of "modern monetary theory" to find support for the view that debt has few consequences.
Olivier Blanchard, of MIT and the IMF, in his Presidential Address to the American Economic Association, (excellent summary here) declared that “there may be no fiscal costs” of additional debt. The core of his argument is that the interest rate on government debt may be lower than the growth rate of the economy so the US can roll over debt forever.
Larry Summers, ex treasury secretary, President of Harvard, and adviser to presidents, surely the preeminent policy economist of our generation, has advocated that additional debt-financed spending may have so strong a multiplier as to pay for itself. (Paper here)
As a result “expansionary fiscal policies may well reduce long-run debt-financing burdens," a super-Keynesian version of the Laffer curve (I don’t mean to pick on Blanchard and Summers — they are only superbly distinguished representatives of widely held views.)
Unlike MMT, these are logically consistent possibilities. But are they right?
The interest rate on government debt is indeed slightly lower than good guesses of the economy’s growth rate, as sadly low as the latter is, so that if we roll over debt with no additional deficits, the debt to GDP ratio will slowly decline and the US can indeed run this slow-rolling Ponzi scheme.
But how long will this happy circumstance of ultra-low interest rates continue? More to the point, how scaleable is this opportunity?
Bond market investors lend 100% of GDP to the US government at 1% interest. Will they lend 200% of GDP at the same low interest rate, or will they start to require higher interest rates?
A government that finances itself only with money and no debt need not pay back the money -- but, obviously, cannot double the opportunity.
What happens when, rather than grow out of a given debt, the US piles on larger and larger debt to GDP ratios each year?
The analysis is about sustainability of a large, but steady debt to GDP ratio. It does not justify a debt to GDP ratio that grows 10 percentage points per year.
At what debt to GDP ratio must the party stop and the growing out of it begin?
Blanchard recognizes these limits are out there somewhere, and that debt crowds out private investment. But just where the limits are is less clear. That finding the limits will be unpleasant is clear.
Summers’ view is likewise limited to a period of “secular stagnation” with perennially deficient demand, sticky prices and wages, and the other requirements of extreme Keynesianism.
Are we in such a period, or is covid a supply shock? Was the economy really suffering lack of demand when unemployment hit 50 year lows last February?
Washington knows no such sophistication, but our politicians have grasped the logical implications of the proposition that debt does not matter with more clarity than have economists.
The notion that debt matters, that spending must be financed sooner or later by taxes on someone, and that those taxes will be economically destructive, has vanished from Washington discourse on both sides of the aisle.
The covid response resembles a sequence of million-dollar bets by non-socially distanced drunks at a secretly reopened bar: I’ll spend a trillion dollars! No, I’ll spend two trillion dollars!
That anyone has to pay for this is un-mentioned. Well, perhaps nobody does have to pay.
And who is to blame them, really? Markets offer 1% long-term interest rates. Blowout spending financed by the Fed printing money — which is no different from debt — has resulted in no inflation so far.
Faced with the deep concerns of current voters, worry that our children and grandchildren might have to pay off debt is not particularly salient. They’re either in the basement playing video games or out protesting for the end of capitalism anyway.
Politicians will take the cheap money as long as markets are happy to provide it.
The economists, even the modern monetary theorists, envision debt issued to finance worthy investments, or valuable spending, all undertaken with a careful green eyeshade approach.
Washington has figured out the logical conclusion of the idea that Federal debt doesn’t matter, in a way these economists have not: If debt and money printing have no fiscal cost, why be careful about how you spend money?
Send checks to voters. Why not?
It’s costless. No boondoggle project is objectionable.
Send billions to prop up dying businesses. Why not?
It’s costless.
Why bother fixing the post office? Send them another $25 billion. Or $100.
Deeper: Why should citizens have to pay back debts if the Federal government does not have to do so?
John H. Cochrane