What are the limits on public borrowing?
TIT SCALE of Joe Biden’s plans is hard to overstate. Where the former boss of US President Barack Obama quickly turned to reducing deficits after the ordeal of the global financial crisis, Mr Biden’s first budget, which he unveiled on May 28, will borrow shameless. The plans assume that annual budget deficits will exceed 4% of the GDP until the end of the decade; net public debt will rise to 117% GDP in 2030 against 110% today. Generosity raises two big questions. One is whether, on top of past stimulus packages, this will contribute to overheating the US economy in the near term. The other important question is whether, in the longer term, America can prudently afford to loosen the purse strings for an extended period of time. As the crisis hit and interest rates fell, politicians felt more able to take on debt than in the past. But the question of whether and when borrowing limits might apply remains. Recent research highlights these constraints.
In a new working paper, Atif Mian of Princeton University, Ludwig Straub of Harvard University and Amir Sufi of the University of Chicago attempt to assess the leeway of governments. Their analysis (which does not incorporate the effects of the pandemic) draws on recent work that estimates how the “convenience yield” on government bonds – or the amount by which the yield on a bond is reduced because of the security and liquidity benefits it offers to investors – varies depending on the size of the debt burden. All other things being equal, the greater the volume of bonds in circulation, the higher the return demanded by investors. The work of Arvind Krishnamurthy of Stanford and Annette Vissing-Jorgensen of the University of California at Berkeley suggests, for example, that a 10% increase in the debt / GDP pushes government bond yields up 0.13 to 0.17 percentage points. (In practice, of course, other factors are not always equal: the long-term effect of increased bond supply on safety and liquidity premiums may be offset by other factors, such as a short-term surge in asset demand instability, leading to lower bond yields amid growing leverage.)
Because the supply of bonds is large, write Mian and his co-authors, too low a level of public debt can lead to an interest rate tending towards zero. But the rates cannot go much further below zero; this results in a narrower room for maneuver for central banks to stimulate activity, and therefore lower economic growth and higher unemployment. Debt sustainability issues are often associated with high debt levels, which push the interest rate above the rate of economic growth. When this condition is met, the debt burden increases steadily, even in the absence of new borrowing. But the authors point to the theoretical possibility of another source of fiscal sustainability problems: when too low a debt level leads to significant deflation, pushing the growth rate into negative territory and below the interest rate.
Between these two extremes, say the researchers, is a “Goldilocks zone” in which a tax-free lunch is possible. They flesh out a point made in 2019 by Olivier Blanchard of the Peterson Institute for International Economics: when the interest rate on public debt is lower than the rate of growth of the economy, the burden of existing debt has virtually no cost. budgetary. In such cases, existing debt will decrease in proportion to output even if no new taxes are levied, although a government that continues to run deficits may nonetheless increase its debt. Assuming a balanced budget and based on estimates of the convenience yield of Treasuries, the authors estimate that the US Goldilocks Zone – the maximum level of debt you could reach and then stabilize without raising taxes – could extend up to about 260% of GDP. (The uncertainty surrounding their estimates means that the limit could be between 230% and 300% of GDP.)
There is also a range of debt through which governments can run deficits in perpetuity without increasing the debt burden. America, they estimate, could run a deficit of 2.1% of GDP as long as its debt is less than 130% of GDP (beyond this threshold, the largest deficit that could be managed in a sustained manner without increasing the debt burden falls steadily towards zero).
This logic suggests that while oversized deficits may be appropriate now, America cannot handle them forever. This would lead to increased debt, potentially outside the Goldilocks zone and into riskier territory. And the longer America waits to reduce its deficit to the maximum sustainable level, the closer that level will be to surplus (or further into surplus). Mr. Biden can be reassured that his borrowing is manageable at the moment. Even so, it could potentially limit America’s tax freedom.
It is important to note that a Goldilocks window is not fixed. A slowdown in economic growth could reduce the safety zone by narrowing the gap between growth and interest rates, unless an economic slowdown also causes interest rates to drop sharply, bringing them closer to zero and in need of fiscal stimulus. Rising inequalities can lead to calls for redistribution, but as the rich tend to buy government bonds in disproportionate numbers, leveling the income distribution can reduce the possibilities of a free meal plan. tax. It also means, the authors note, that efforts to close large deficits through progressive taxes may not bear much fruit: taxes on high incomes will accumulate money that could be used to buy obligations.
Analyzes like these attempt to understand circumstances outside of historical experience and are necessarily accompanied by great uncertainties and assumptions. Politicians in charge of budgeting also have uncertainties to deal with and should do so with caution. Public borrowing plays a leading role in today’s macroeconomic trend. Some kind of balance is always needed, between making good use of the state’s borrowing capacity and recognizing that the limits of public borrowing are not so far off that they can be completely ignored. ■
This article appeared in the Finance and Economics section of the print edition under the title “Rythme tes dettes”