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Financial Repression Revisited?

Although massive current spending in response to the COVID-19 pandemic seems justified, policymakers will have to address the mounting public debt once the crisis has passed. Policymakers will be strongly tempted to impose an interest-rate ceiling on financial institutions, but conditional tax increases would be preferable.

WASHINGTON, DC – The US federal debt-to-GDP ratio rose sharply during the 2008-09 Great Recession and continued rising thereafter, going from 62% in 2007 to 90% in 2010. By 2019, it had reached 106%, and the Congressional Budget Office was warning that the trust funds for Social Security and Medicare would be exhausted by 2028. Many economists argued that a debt-to-GDP ratio of 100% was already worryingly high, and that the future tax increases needed to reduce it would be massive.

Then came COVID-19. Faced with lockdowns and collapsing economic activity, governments around the world approved vast additional expenditures even though revenues were expected to decline. After projecting an annual fiscal deficit of $1 trillion before the pandemic, the CBO has raised its estimate of the deficit for fiscal year 2020 (which ends in September) by an additional $2.2 trillion, followed by an additional $0.6 trillion in 2021. According to the Committee for a Responsible Budget, this amounts to 17.9% of GDP in 2020, and to 9.9% in 2021. As things stand, the federal debt is expected to reach 108% of GDP by next year.

This means that in the space of just seven months, the US debt ratio has already exceeded the level accumulated during the two years of the Great Recession, and that doesn’t even account for additional spending bills that Congress has yet to pass. The consensus view is that these expenditures are justified, given the unprecedented, horrific circumstances of the pandemic. Nonetheless, policymakers must recognize that measures to reduce the deficit-to-GDP ratio will be urgently needed after the virus has been brought under control.