How Much Debt Is Too Much?

Nov 30, 2020 Raghuram G. Rajan

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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0 Comments on this paragraph, 29 Comments on this article

Edward Heilbron Dec 20, 2020

“Free lunches” are likely available for currency-issuing countries (as compared to countries that MMT defines as “currency users”) when productive unemployed labor and spare productive capacity are available. In general, any system that runs inefficiently can be re-tuned to operate at a more efficient level...and in so doing, enjoy a free lunch. That said, MMT does not claim unlimited free lunches, and any reading as such, is a mis-reading.

See “The Deficit Myth”, Chapter 2, p 41: “MYTH #2: Deficits are evidence of overspending. REALITY: For evidence of overspending, look to inflation.”
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Francisco Flores Dec 7, 2020

RE: "... But investors will buy that new debt only if they are confident that the government can repay all its debt from its prospective revenues. ... ..."
• But if it can be funded directly or indirectly by Central banks, why would anybody care what investors think?
- Joshua Oswana Dec 7, 2020
  
  I am no expert on the issue but Prof. Rajan may be referring to the fact that there is one market for government debt issuances (whether bought by the Central Bank or investors). Unless you are willing to have ALL debt held and bought by the Central Bank, you will likely need to care about what investors think.
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Francisco Flores Dec 7, 2020

RE: "... Over the medium term, however, this approach does not allow it to borrow any more than it could have by financing directly. ... ..."
• So why are we having this conversation? Have the Central Bank finance directly.
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Francisco Flores Dec 7, 2020

RE: "... Moreover, with much of the newly issued sovereign debt now paying negative interest rates, additional borrowing stands to reduce interest expenses even more. ... ..."
• Interest rates are whatever the Central Banks say they are. This puzzling over why interest rates are low is nonsense.
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Francisco Flores Dec 7, 2020

RE: "... 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. ... can simply print money to pay off maturing debt, and this should not result in inflation as long as there is sizable unemployment...."
• Actually the criteria is that a monetary sovereign that issues, borrows in, and floats its own currency can never run out of cash and is not vulnerable to a hyperinflation.
• The spare productive capacity condition is for additional fiscal spending.
• Paying off the national debt will not result in inflation if the replacing deposits have similar yields and duration as the securities redeemed or purchased. Again, sizable unemployment is a condition of incremental fiscal spending, not a limitation on paying off the debt through Central Bank monetization.
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Alexandros Aslanidis Dec 6, 2020

Utter nonsense. No need to lure investors. The bonds can be bought directly by the central bank, and they can mature in eternity with 0% interest. Τhe central bank is the one who controls interest rates, not the commercial banks or investors. In fact, while we're at it, why doesn't the central bank just withdraw the bonds, since for all intends and purposes they are non-existent? That would put the pretense to rest.

Now, to be sure, emerging markets do need foreign currency in order to finance imports and investments in areas where they lack know-how or specialized machinery. But rather than issue bonds in foreign currency, it's better to finance them through exports, equity, and FDI. That way, the "sudden stops" in fickle capital flows wouldn't matter.
- Francisco Flores Dec 7, 2020
  
  Exactly!
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Ralph Musgrave Dec 6, 2020

Raghuram Rajan’s claim that MMTers and like minded people think governments scan “spend without limit” is utter nonsense. MMTers have repeated over and over till they’re blue in the face that inflation puts a limit on the sized of spending and deficits.
- New Cavendish Dec 6, 2020
  
  Mr. Rajam's discussion sounds right to me. The biggest problem with MMT is that the "theory" doesn't seem to include any credible mechanism to determine when inflation limits are being reached or how to put on the brakes; I'd like to see some MMT public-sector accounts and some worked examples about how it could be managed in real life if I am asked to believe in it. Otherwise, it sounds like Argentina. I think we need to go back to the more reasonable versions of Keynesianism, which kept in mind the need for consolidation in good times, which legitimized high borrowing in bad times.
  - Jack kessler Dec 7, 2020
    
    "The more reasonable versions of Keynesianism, which kept in mind the need for consolidation in good times, which legitimized high borrowing in bad times" -- I didn't know there was any other, it's the general message of the General Theory as I understand it that good-times-consolidation is to balance bad-times-borrowing, in the long run... even if in the long run we are all dead... Both Keynes' critics & defenders have ignored that good-times mandate, favoring the greater political drama of the bad.
    - Ralph Musgrave Dec 9, 2020
      
      MMT is quite right to ignore the “consolidate in good times mandate”. Reason is that consolidation equals confiscating some of the private sector’s stock of money (base money to be exact) and/or its stock of secure savings, i.e. government debt. If the private sector has less of that stock than it wants, it will save in an attempt to acquire that stock, and we get Keynes’s “pradox of thrift” unemployment.
      
      Which leads to the basic MMT principle that the deficit and debt should be whatever gives us full employment while hitting the inflation target plus a zero or near zero rate of interest on government debt.
      
      That basic principle will certainly lead in some cases to consolidating in good times, but it won’t NECESSARILY do so.
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  - Ralph Musgrave Dec 6, 2020
    
    Systems for "determining when inflation limits are being reached" can be exactly as they are now. I.e. the central bank looks at a variety of things: the price of goods a typical household buys in a week, rate at which wages are rising and so on.
    - New Cavendish Dec 6, 2020
      
      Those are the metrics; what's not clear is how the metrics will be applied, especially if it is intended to be a political decision by the political institutions, rather than a technical decision by the central bank. Maybe I am dense but I don't see how that is to be enforced, and if it isn't enforceable, the natural political tendency will be to drive us to Argentina.
      - Ralph Musgrave Dec 7, 2020
        
        The desire by politicians to override central bank decisions is ALWAYS a problem: i.e. it's no more a problem under an MMT regime than any other regime.
        
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      - Francisco Flores Dec 7, 2020
        
        New: You are correct to an extent. (Not on the Argentina side as they're problem was borrowing in a foreign currency. As I've mentioned before, a monetary sovereign that issues, borrows in, and floats its own currency - like say the US or UK- can never run out of cash and is not vulnerable to hyperinflation.)
        
        Some MMT folk propose the following as a credible inflation offset: Inflation is easily managed in these circumstances. For example, the Job Gty/Green New Deal law should include AUTOMATIC across-the-board tax increases that kick in when certain monthly wage inflation target are hit-say for 6 months in a row. These can include:
        a) Income Taxes,
        b) Sales/VAT Taxes
        c) Asset Value (or Wealth) Taxes
        That'll cool things off pronto.
        
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Thaomas H Dec 3, 2020

Many of the specific points Rajan makes are not wrong, but the frame is wrong. How much debt is good or bad in not independent of how the debt arises. If a person or a nation borrows $1 or $ 1T that is great if the rate of return is greater than the cost of borrowing and bad if the rate of return is less. The tricky part is estimating the rate of return and the cost of borrowing (trickier for a nation than a person), but the issue is not "debt."
- Francisco Flores Dec 7, 2020
  
  A sovereign that issues, borrows in, and floats its own currency can never run out of cash and is not vulnerable to hyperinflation.
  
  Also, the interest rates is whatever the Central bank says they are. (By the way, what was the internal rate of return of winning WW2?)
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- Edward Hatfield Dec 6, 2020
  
  I think I am wiser in that it shows me how mainstream economists funded by right wing Oligarchs find theories to justify crazy policies.
  "Countries that issue debt in their own currency and have spare productive capacity".
  I see it from a UK perspective but I think our productive capacity is falling or would be if we stopped increasing the population with skilled imported labour, and the social upset that is causing with or without Brexit is destabilizing our society. There is worldwide an almost unlimited supply of cheap labour but that is also coming to an end for social reasons and rebellions from the left behind.
  Ceated money is mainly ending up in unproductive assets and not being spent by or benefitting the poor. Much of the money will disappear when/if there is a crash in asset prices and debt liquidation and the social upheaval which is clearly in progress will crash any economic theory from a mathematician who believes he does not need to consult or refer to sociologists.
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George lesperant@gmail.com Dec 3, 2020

Why do serious economic commentators continue to use the misleading phrase "print money"? Create money is the correct phrase. Is it because the correct wording draws, even educated readers, into the complexity of the phenomenon which is "money"? More particularly it points to the misty relationship between fiat money, the state and the future (of the state, inter alia).
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Jaspal Singh Dec 3, 2020

This leads you nowhere. Tell me if anyone is wiser after reading this article how much debt can her country hold? Mr. Raghu Ram let me tell you that if on average a country is incurring fiscal deficit of say 5 percent of GDP and growing at a annual rate of 4 percent and maintaining inflation at 3 percent then it's debt to GDP ratio will converge to 76 percent. Supposing bond yields are 6 percent then the interest payment will be 4.56 per cent which less then fiscal deficit of 5 percent. This level of debt will be sustainable for the country. However, sustainability doesn't guarantee optimality. This type of sustainable debt and fiscal deficit shall also be optimal if they neither lead to crowding out of private investment nor to higher inflation. This will be the case if net borrowing doesn't exceed the unabsorbed savings in the economy. Hope, I have been clear!!
- Francisco Flores Dec 7, 2020
  
  A sovereign that issues, borrows in, and floats its own currency can never run out of cash and is not vulnerable to hyperinflation. The US government debt, for example, is not a problem in any way shape or form. In fact, it can be repaid tomorrow without a negative repercussion. That would simply involve replacing government bonds with deposits at the Federal Reserve Bank with similar interest and maturities. The similar or even better risk/reward terms assure no change in investor savings/spending preference or desire to hold dollars. Not recommending this course of action, just pointing out that it is possible.
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Alan Luchetti Dec 2, 2020

There is no assertion of a "magic money tree" in the recognition that central bank reserves appear "out of thin air".

http://andolfatto.blogspot.com/2011/03/out-of-thin-air.html

Central banks book reserves as the promises / debt / liabilities that they are. So revenue is debt redemption, not asset transfer, and bond sales are debt swap with coupon fiscal injection, not borrowing; which is to observe that neither revenues nor bond sales finance spending which is a process of legislative authorisation, executive disbursement, payee banking and central bank reserve (debt) issuance.

Estimated present deficit is a trigger that arbitrarily determines the respective contributions of treasury debt and central bank debt to total debt. It is this total debt, infinite in potential capacity, which must be calibrated to the finite real resource capacities of the economy. In that calibration task, any hint of "magic" disappears.

Whether or not revenue and "borrowing" are seen as "funding", in which case the r<g story parallels fiscal reality, there cannot be too much emphasis on the necessity for spending to expand, as well as observe, the real resource capacity of the economy. But too much can be made of the distinction between "high-return infrastructure projects", and investment in other capacities such as a skilled and healthy workforce and social cohesion; or in preservation of capacity by investment in a non-catastophic climate.
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Jaspal Singh Dec 1, 2020

This leads you nowhere. Tell me if anyone is wiser after reading this article how much debt can her country hold? Mr. Raghu Ram let me tell you that if on average a country is incurring fiscal deficit of say 5 percent of GDP and growing at a annual rate of 4 percent and maintaining inflation at 3 percent then it's debt to GDP ratio will converge to 76 percent. Supposing bond yields are 6 percent then the interest payment will be 4.56 per cent which less then fiscal deficit of 5 percent. This level of debt will be sustainable for the country. However, sustainability doesn't guarantee optimality. This type of sustainable debt and fiscal deficit shall also be optimal if they neither lead to crowding out of private investment nor to higher inflation. This will be the case if net borrowing doesn't exceed the unabsorbed savings in the economy. Hope, I have been clear!!
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Phil 1 Dec 1, 2020

There are no bond vigilantes demanding high yields and there never will be. You have the basic mechanism down but your causality is all off. When Treasury spends, it does so by crediting the bank account of someone in the private sector. That shows up as reserves on a bank's balance sheet. The bonds treasury created in tandem with that spending will gladly be purchased by whatever bank ended up with the reserves because it's always better to have an interest paying asset. Whatever happens in the secondary market for bonds is entirely irrelevant to funding the government.
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francisco goncalves Nov 30, 2020

Dear Mr. Rajan, I'm not interested on defending MMT, which, I think, is not even a theory. But I really don't understand your reasoning about allowing for higher inflation. If the economy reaches full employment that's because declining liquidity preference has absorbed created money by then. The rise in interest rates seems to me a deflationary surce. We could have an economy in recovery and rising interest rates. If the economy, as I imagine, stays depressed, that's because the government didn't make new money reach directly the hands of those who will spend, not satisfy their luqidity preference.
- B. Troer Dec 6, 2020
  
  Willing to spend strangers money because at a state owning market state trade is the basic substance of treasure at a open one trade based upon.
  Likewise unwilling to spend born and unborn to.
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