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Perspectives on debt and deficits.


Vast countries that borrow in their own currency have enormous latitude to run up debt. It's not at all clear why this should be an urgent concern for us right now. If r is less than g, if the interest rate you pay on the debt is less than the growth rate of the economy, then the debt to GDP ratio stabilizes even if you run a primary deficit. That says that if you want to run deficits to spend on something productive, you don't need to worry about a debt spiral. We're in a world where interest rates tend to be low even in good times; we are in a world which looks a whole lot like a secular stagnation world. In that kind of world, having persistent deficits can actually be a positive thing. If our debt would cause the foreign flow of money to the U.S. to slow down, that would also mean, by definition, a smaller trade deficit achieved through a weaker dollar.

Keywords Debt * Deficits * r minus g * Debt spiral * Secular stagnation


There are some people out there who say that debt never matters, it's never a concern. I'm not in that camp. I think that it can matter. It can be a problem. The question is how important is it in the context of where we are now. I think you would have a hard time putting government debt into the top ten list of problems that we face. It's just not that major an issue.

I think that looking at where debt in the United States is, relative to our own history, is way too narrow a view. You want to look across the history of other countries; the history of what we've seen in the world. Take the case of Britain, which has a long history. Britain had debt in excess of 100% of GDP for most of the 20th century. It almost became funny, that during the discussion about austerity policies in Britain, people were saying Keynes may have spoken for his time, but he would never have been arguing for Keynesian policies if Britain had had the kind of debt level it has now. It turns out in the 1930s Britain already had debt of more than 100% of GDP, as a legacy of World War I. It didn't have problems with solvency then. It doesn't have problems with solvency now. The idea that debt should be a central focus of policy concern was never justified by the evidence. Japan has gross debt that's 240% of GDP. Interest rates are negative. People who bet on a debt crisis used to call it the widow-maker trade because anybody who bet on that has been losing money year after year after year.

Vast countries that borrow in their own currency have enormous latitude to run up debt. It's not at all clear why this should be an urgent concern for us right now. Clearly, bumping up the deficit to provide a tax cut that is basically being used to buy back stock was not a smart policy. But is that the thing that we should be worrying about most right now?

I would like to go on to say that most of the concerns when we talk about "fiscal space" are kind of undefined. When you try to push people on what are the limits on fiscal space, they end up saying, well, it's about how people will perceive it. Which is kind of saying, "I'm creating this concern and people are going to believe me, and therefore you cannot do the things you want to do," which is a peculiar way to put it. If Japan can have debt that's 240% of GDP and has, in fact, been following a policy of fiscal stimulus, what is the chance that the United States is going to be running out of fiscal space in some concrete fashion, as opposed to the kind of inside the beltway perception, any time in the near future? I just don't see it.

We want to get into the question of how does one even think about the burden of debt with interest rates as low as they are. When we are at or near full employment, as we are, I think (God knows we're not even sure about that these days) then I think there is crowding out. If the Trump tax cut had not been enacted, then the Fed would not have raised rates as much as it has. Interest rates would be a little bit lower and we would have a little bit more, probably mostly residential, investment than we now have. There's some crowding out. If I could take the TCJA and make it go away and replace it with some significant part of the Green New Deal, I'd do it in a heartbeat. Of course, I would probably go with some significant part of the Green New Deal even if we can't get rid of the TCJA.

There are a couple of reasons that the low interest rate changes the story about debt. The most important involves fears that you have about a debt spiral when you have high debt. The concern is that if you have a large debt, that in order to stabilize the ratio of debt to GDP, you need to run a large primary surplus Well, if r is less than g, if the interest rate you pay on the debt is less than the growth rate of the economy, then the debt to GDP ratio stabilizes even if you run a primary deficit.

Further, the higher the level of the debt, the size of the primary deficit that is consistent with a stable debt ratio actually grows. Debt does not crowd out your ability to spend on other things. The stock of debt is not really a problem. The low interest rates are also telling us that the private sector does not see very good investment returns. To the extent that deficits do crowd stuff out, the private sector doesn't think it has any very good use for the money.

That says that if you want to run deficits to spend on something productive, you don't need to worry about a debt spiral. You don't need to worry that you're crowding out highly productive private investment, because the private sector doesn't think it has those great investment projects. In an environment like this, the market is basically trying to tell government, "Maybe you want to borrow some. If you've got some good stuff to spend money on, why don't you actually borrow it?" It's a peculiar thing that we sit here and say, "Well, no. We're economists and we know better than the market." There are times when that may be true, but that's not something you want to act on unless you have very good reason to.

We've learned from Japan. Some of us worried about Japan-type experiences long before they actually happened. There was kind of a Japan worrier caucus at Princeton University when I first went there, which was Mike Wood-ford, Lars Svensson, me, and Ben Bernanke (I don't know what happened to him). We used to castigate the Japanese all the time for not dealing with their problems effectively. I've been proposing that all of us should go to Tokyo and apologize to the Emperor because the fact of the matter is that now that we've seen how we handled a similar crisis, they did better than we did. You took at look at Japan and everybody's very down on Japanese performance. But you really need to adjust for demography. If you look at Japanese growth per working age adult since the early 1990s, it's about the same as ours. The fundamental reason for slow growth in Japan is not that they've had enormous economic underperformance, but basically just a shortage of Japanese. The idea had been that Japan had given some needed lessons about the need to address debt problems. There is a mild, very mild negative correlation across nations between debt levels and growth. But almost certainly the causation runs the wrong way. Aside from Japan, Italy has high debt, but that's because Italian growth collapsed. It's not that Italian growth collapsed because of high debt.

Turning back to the Japanese performance, Japanese monetary policy was too conventional. They allowed themselves to slide into deflation, which they didn't need to. If they hadn't done that, they'd be in even better shape than they are. After all of those years of deficit spending, they have a lot of debt which doesn't seem to be doing any harm. It certainly hasn't made the markets question their credit worthiness. They've never had the kind of mass suffering that we had after 2008. They're still there. Japan is hanging together as a society better than we have.

Demography is probably the single best guess about why interest rates are so low. That's the original secular stagnation hypothesis. Alvin Hansen was about demography, was about slowing population growth. He was wrong at the time because of the baby boom. But if you ask now, the reason why Japan got into this low interest rate liquidity trap environment 10 years ahead of the rest of us is probably demography. The reason that Europe is persistently weaker than we are has a lot to do with demography, because working age population growth is negative in Europe now.

Because we're in a world where interest rates tend to be low even in good times, we are in a world which looks a whole lot like a secular stagnation world. It's a world in which slumps in which you hit the zero lower bound happen often. That's what secular stagnation means. Not that you never grow but that you're constantly at risk of finding yourself in slumps that can't be fought with monetary policy. In that kind of world, having persistent deficits, having debt to the extent that the private sector regards the debt as net wealth and, therefore, saves a bit less, can actually be a positive thing. It's certainly a reason why any kind of extraordinary efforts to reduce debt in the current environment are almost surely self-destructive.

I've seen a lot of people quoting Olivier Blanchard, as they should because Olivier's the most balanced man on Earth. He says, "Well, we've been overstating this debt thing." There's an excellent paper also making this point by Furman and Summers. One of the wonderful things about Olivier's paper was that he pointed out that r less than g is the historical norm. It's not an exceptional thing. The exceptional thing was that period in the early '80 s of aggressive disinflation with the Fed raising rates sky high to squeeze inflation out of the system. Aside from that, r is almost always less than g.

Let me talk about the vulnerability to flight by foreign investors, because that's a risk that people constantly raise. It's a constant concern, and yet if you try to come up with examples of countries that borrow in their own currency that have had crises because foreign investors lose confidence, I believe you come up blank. Argentina borrowed in dollars. Greece borrowed in euros. If you actually look for a country like us that borrows in its own currency and saw flight, the closest I can come up with is France in the '20s. But, even then, it was really not a big problem. Under the current circumstances, if the foreign flow of money to the U.S. were to slow down, that would also mean, by definition, a smaller trade deficit achieved through a weaker dollar. A smaller trade deficit would help us in many ways macro-economically. It would make it easier for us to maintain full employment, which is a plus. If the dollar were to weaken by 10%, 20%, why would that be a crisis for a country like the U.S? Because we don't have large debts in foreign currency, public or private, there are no balance sheet issues that arise. We're in a peculiar situation where our net international investment position improves when the dollar depreciates.

Under the circumstances of chronic large deficits and growing debt will the Fed ever be able to shrink its balance sheet? I think it can. But it's also not clear what the urgency of the Fed is in doing that. What are the problems that are being created by the fact that the Fed owns a bunch of longer-term securities as well as T-bills, or just that it has a large balance sheet? It's not clear that there's any actionable cause for concern there. It makes people uncomfortable, but that's a little bit like the fiscal space argument. Again, it's kind of saying, "I worry about this because other people might worry about it." It's almost kind of circular logic.

If you're on the progressive side of this thing you should be thinking about paying for three kinds of spending. There is infrastructure investment. The question is how should we pay for investment? The answer is we shouldn't. We should borrow. Borrowing costs are low. Private investment opportunities are low. Even if there is some crowding out, it's worth doing. Second is what I've been calling benefit enhancements, which require moderate amounts of government spending. Those probably should be paid for, but they can be paid for with narrow based taxes. They can be paid for with taxes on high incomes, as Obamacare was. If you want to have a Scandinavian welfare state, you have to have Scandinavian levels of taxes. I'm fully on for PAYGO on that from broad-based taxes. My guess that's not going to happen in the next 4 years or in the next 10 years but it's worth talking about. For the kinds of things we can do in the near term I'm for some revenue increases. In the long run we're going need more of those. However, some benefit enhancements should be paid for by borrowing. Child nutrition and child health care are clearly things you can think of as investments, although they're very long-term investments.

In conclusion, there's enough stuff on the progressive agenda that is really clearly investment, that I think would use up even my amount of borrowing. Then the other items on the agenda probably should be paid for through taxation.

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Paul Krugman joined The New York Times in 1999 as an Op-Ed columnist. He is distinguished professor in the Graduate Center Economics Ph.D. program and distinguished scholar at the Luxembourg Income Study Center at the City University of New York. In addition, he is professor emeritus of Princeton University's Woodrow Wilson School. In 2008, Mr. Krugman was the sole recipient of the Nobel Memorial Prize in Economic Sciences for his work on international trade theory. Mr. Krugman received his B.A. from Yale University in 1974 and his Ph.D. from M.I.T. in 1977. He has taught at Yale, M.I.T. and Stanford. At M.I.T. he became the Ford International Professor of Economics. Mr. Krugman is the author or editor of 27 books and more than 200 papers in professional journals and edited volumes. His professional reputation rests largely on work in international trade and finance; he is one of the founders of the "new trade theory," a major rethinking of the theory of international trade. In recognition of that work, in 1991 the American Economic Association awarded him its John Bates Clark medal. Mr. Krugman's current academic research is focused on economic and currency crises. At the same time, Mr. Krugman has written extensively for a broader public audience. Some of his articles on economic issues, originally published in Foreign Affairs, Harvard Business Review, Scientific American and other journals, are reprinted in Pop Internationalism and The Accidental Theorist.

Paul Krugman (1)

Published online: 15 April 2019

Prepared from remarks presented at the session Perspectives on Fiscal Policy at the NABE Economic Policy Conference, February 27, 2019.

[mail] Paul Krugman

(1) City University of New York Graduate Center, New York, NY, USA
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