America, they estimate, could run a deficit of 2.1% of GDP for ever so long as its debt is below 130% of GDP (after which threshold the largest deficit that could be run in sustained fashion without raising the debt burden drops steadily towards zero). There is also a range of indebtedness across which governments may run deficits in perpetuity without increasing the debt burden. (The uncertainty around their estimates means the limit could lie between 230% and 300% of GDP.) Assuming a balanced budget and based on estimates of the convenience yield on Treasuries, the authors reckon that America’s Goldilocks zone-the maximum level of debt you could reach and then stabilise without raising taxes-could extend up to about 260% of GDP. In such cases, existing debt will decline as a share of output even if no new taxes are levied-though a government that continues to run deficits may nonetheless add to its debt pile. They flesh out a point highlighted in 2019 by Olivier Blanchard of the Peterson Institute for International Economics: that when the interest rate on public debt is below the economy’s growth rate, existing debt burdens have essentially no fiscal cost.
THE BALANCE GOLDILOCKS ECONOMY FREE
In between those two extremes, the researchers argue, lies a “Goldilocks zone” in which a fiscal free lunch is possible. But the authors raise the theoretical possibility of another source of fiscal-sustainability problems: when too low a level of debt leads to serious deflation, dragging the growth rate into negative territory and below the interest rate. When that condition is met, the debt burden grows steadily even in the absence of new borrowing. The problems of debt sustainability are often associated with high debt levels, which push the interest rate above the economic-growth rate. But rates cannot fall much further below zero the result is narrower scope for central banks to stimulate activity, and therefore lower economic growth and higher unemployment. (In practice, of course, other things are not always equal: the long-run effect of increased bond supply on safety and liquidity premia may be offset by other factors, such as a short-run surge in demand for safe assets prompted by financial instability, leading to falling bond yields amid rising debt loads.)īecause the supply of bonds matters, Mr Mian and co-authors write, a level of government debt that is too low can result in an interest rate that slinks towards zero. Work by Arvind Krishnamurthy of Stanford and Annette Vissing-Jorgensen of the University of California, Berkeley, suggests, for example, that a 10% increase in the ratio of debt to GDP pushes government-bond yields up by 0.13-0.17 percentage points. Other things equal, the greater the volume of outstanding bonds, the higher the return investors demand. Their analysis (which does not incorporate the effects of the pandemic) builds on recent work that estimates how the “convenience yield” on government bonds-or the amount by which a bond’s yield is reduced because of the safety and liquidity benefits it offers investors-varies with the size of the debt burden. In a new working paper, Atif Mian of Princeton University, Ludwig Straub of Harvard University and Amir Sufi of the University of Chicago attempt to gauge governments’ room to run. Recent research casts light on these constraints.
But the issue of whether and when limits to borrowing might apply still remains. As crisis has hit and interest rates have fallen, politicians have felt more able to run up debts than in the past. The other important question is whether in the longer term America can prudently afford to loosen the purse-strings for a sustained period.
One is whether, coming on top of past stimulus packages, it will contribute to an overheating of America’s economy in the short term. The plans assume that annual fiscal deficits will exceed 4% of GDP through to the end of the decade net public debt will rise to 117% of GDP in 2030 from 110% today. Where the American president’s former boss, Barack Obama, pivoted quickly to deficit-cutting after the trials of the global financial crisis, Mr Biden’s first budget, which he unveiled on May 28th, will borrow unapologetically. T HE SCALE of Joe Biden’s plans is hard to exaggerate.
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