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How Much Debt Is Too Much?

The new conventional wisdom in these unconventional times is that advanced-economy governments can take advantage of today's ultra-low interest rates to borrow and spend without limit in order to support the economy. But the fact is that there is always a limit, and it may come into view sooner than many realize.

CHICAGO – As the COVID-19 pandemic rages, governments in advanced economies have opened their coffers to support households and small businesses, spending on the order of 15-20% of GDP in many cases. Cumulative debt levels now exceed GDP in many developed countries; and, on average, debt as a share of GDP is approaching post-World War II highs.

Nonetheless, according to Olivier Blanchard and other economists, advanced economies can afford to take on much more debt, given the low level of interest rates. Calculations using International Monetary Fund data show that in the two decades before the pandemic, sovereign interest payments in these countries fell from over 3% of GDP to about 2%, even though debt-to-GDP ratios increased by more than 20 percentage points. Moreover, with much of the newly issued sovereign debt now paying negative interest rates, additional borrowing stands to reduce interest expenses even more.

In this strange world of ultra-low interest rates, what limits are there on government borrowing? According to advocates of Modern Monetary Theory (MMT), there are none, at least not for countries that issue debt in their own currency and have spare productive capacity. After all, the central bank can simply print money to pay off maturing debt, and this should not result in inflation as long as there is sizable unemployment. No wonder MMT has become the go-to idea for politicians advocating government spending to alleviate every problem.

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