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Reckless Caution: The Stress and Strain of Sovereign Debt

On average, higher debt correlates with lower economic growth. This is what studies by the IMF, the Bank for International Settlements, and Reinhart-Rogoff show. Causality could run both ways, especially if more debt is piled upon existing debt in post-crisis efforts to restart growth. However, the first movement, which actually fits the prediction of textbook macroeconomics, is from unchecked debt to slower growth and stagnation.

Up to a certain point, public borrowing smooths a country’s investments in public goods, technology, and education across generations without immediate, drastic consequences on taxation and the private borrowing of current generations. Up to a point, also, public borrowing stimulates private investment by easing general credit conditions. It facilitates growth, and -- to the extent it is desirable -- can help stabilise an economy.

In the absence of enforceable national or international budget-balancing laws, there is literally no limit on the size of the debt that the government of a country with its own currency can owe to citizens and foreigners. In a mythical world of constantly stable economic growth and fiscal revenue, debt can be rolled over until it disappears off the radar screen.

In practice, large debt has proved dangerous. The constraints that debt can impose on state policy make it the most common source of sovereign-level risk.