The Government Debt Bomb

STANFORD – As economies around the world return to growth after the deepest recession in a generation, renewed attention is being paid to enormous fiscal deficits and vast expansions of government debt. This year’s projected deficits (as a share of GDP) are estimated to be a remarkable 13.5% for the United States, twice the previous record at the depth of the horrific early 1980’s recession. Among other major economies: the United Kingdom, 14.4%; France, 8.2%; India, 8.0%; Japan, 7.4%; Italy, 5.4%; Germany, 4.7%; China 4.2%; and Canada, 2.4%.

In addition to the automatic decline in tax revenues and increase in social-welfare spending during a recession, many nations added large spending increases and/or tax cuts to try to stimulate their economies. The increase in the deficit is the sum of these “automatic stabilizers” and discretionary programs. The discretionary policy response has been largest in the US, at a cumulative 4.8% of GDP, and China, at 4.4%, over 2008-2010, while it has been modest in Germany and Canada, and smaller in the UK, France, and India.

The automatic increase in the deficit has also been largest in the US, modest in the UK and Germany, and smaller in Japan, India, Canada, China, France, and Italy. These automatic effects should soon begin to reverse as economic activity recovers, but there is much debate, including at the G-8 and G-20 meetings, over whether the discretionary stimulus should be extended or ended, repeated or reversed.

Since every dollar, euro, yen, rupee, or yuan borrowed today requires the same present value in future interest payments – and therefore future taxes – there are important long-term costs to balance against whatever benefits the deficits create today; there is no fiscal free lunch.