Wednesday, April 17, 2013

"Ample theoretical reasons to worry about debt..."

Rogoff and Reinhart seem to be debunked, at least somewhat, but fear not -- the result is still true!
9.  There are still ample theoretical and empirical reasons to worry about debt.  To name just a few:
a.  "Crowding out": the logic of Clintonomics.  If the government borrows too much, the private sector doesn't have money to invest.  Pretty certain that this doesn't apply in America or Europe right now, but it certainly has and could in other times and places.
Government deficits are what gives the private sector money to invest. If the government taxed back all the money it ever printed, I would have no money for anything.
b. Debt crisis: these are ugly, and often accompanied by other ugly, destructive things,like hyperinflation.  Of course causality runs both ways; countries in trouble are more likely to get into a debt crisis.  But the more debt you have on the books, the higher the risk that a downturn tips you into crisis.  Sudden fiscal contractions are much worse for the economy and other living things than gradual winddowns.  
Hyperinflation is definitely a problem, and the reason to worry about running too high debt/deficits. Good thing we have no sign of it here, and Japan has had no sign of it for a generation and counting.
 c. Debt dynamics driving fiscal contraction:  Well short of an all-out crisis, if your interest rates start rising faster than inflation, you start having to either raise taxes or cut spending; usually both.  That slows your GDP, at least in the near term.  
Interest rates are set by the Government, up and down the yield curve depending on how they choose to manage their QE. If you see rates go up, you don't actually need to do anything unless you want the rates to be different.
d. Income redistribution: worth noting that repaying a big debt load usually involves cutting spending or raising taxes on middle class folks who have to cut their own spending, and giving that money to capital owners.  Some of those owners are outside your country, so you don't even get derivative benefits.
Repaying debt involves changing numbers in a spreadsheet. Paying down debt involves running surpluses, but you would only do this if there was a problem with inflation. How you would run surpluses through taxes and spending, and where that incidence falls, depends on implementation.


Blogger Ralph Musgrave said...

Re “a”, if government simply borrows, period, then I agree that crowding out can take place. But that is not what the government / central bank machine actually does: what they actually do when stimulus is needed is to borrow and then the central bank will buy back whatever amount of debt is needed to make sure interest rates don’t rise. So I don’t see how crowding out occurs.

Re “b”, the extent to which more debt (and/or monetary base) increases the risk of hyperinflation is very debatable. Of course the private sector could go mad and try spending the latter net financial assets all at once. But exactly the same hyperinflation would ensue if the private sector went into irrational exuberance mode even when debt/monetary base levels are very low.

Indeed, even given ZERO debt and monetary base, the private bank system will supply oodles of new money for private sector entities to go wild with if that’s what the private sector wants. In the 3 years prior to the crunch, privately created money was expanding in the UK at about 10% a year as opposed to 5% a year for the monetary base.

Re “c”, you claim that if debt has to be paid off, it can only be paid off via increased taxes or reduced public spending. Er . . . how about QE? In other words if investors do not want a LONG TERM commitment to a particular country or currency in the form of buying its debt, that’s no problem at all. All the country has to do is print money and pay off debt as it matures.

As to interest on debt that is not near maturity, that is determined when the debt is first issued, and is not influenced by subsequent changes in investor confidence.

As to any inflationary effects of QE, I haven’t noticed any hyperinflation resulting from the unprecedented amounts of QE that have been implemented in recent years. But to the extent that there is any excess inflationary effect, that is easily dealt with via increased taxes or public spending cuts. As long as the deflationary effect of the latter equals the stimulatory or inflationary effect of the QE, there is NO NET EFFECT on GDP, numbers employed, inflation, or anything else.

At least the latter is true for a closed economy. For an open economy, i.e. where foreigners want their debt holdings repaid there is an exchange rate effect which would depress living standards in the relevant country – ASSUMING those creditors take their money out of the country. Of course they might not do: they might just sell their government debt and re-invest inside the relevant country.

11:30 PM  

Post a Comment

Subscribe to Post Comments [Atom]

<< Home