Public debt after the pandemic

Another extract from my book-in-progress, Economic Consequences of the Pandemic

Over the course of the Covid-19 pandemic, governments around the world have issued huge amounts of public debt, much of which has been purchased by central banks. In the US, for example, Federal public debt increased by $3 trillion over the course of 2020 (this is about 15 per cent of US national income)

while the monetary base (money created directly by the Federal Reserve) increased by around $1.6 trillion. This money was used to buy government bonds along with corporate securities in open market operations (what is now called Quantitative Easing)

Update Important but complicated: the Treasury has been overfunding its spending needs by issuing securities, and then depositing the excess proceeds at the Fed. To accommodate this, the Fed has increased its secondary market purchases of Treasurys. Netting out the Treasury account, the Fed’s balance sheet is $5.6 trillion rather than $7.2 trillion. Moreover, the post-COVID balance sheet expansion was $1.7 trillion, not $3.0 trillion. (…) Presumably, the latest stimulus package ($900 billion) will draw down much of the Treasury account. If I have it right, this has been accommodated in advance by Fed purchases. End update

These policies represent a complete repudiation of assumptions which were considered unquestionable by the political class until relatively recently: that budgets should be balanced, and that public debt is always undesirable.

Even the most widely-accepted modifications of these assumptions are now problematic. A standard view is that budget balances should be stable over the course of the economic cycle. If measured appropriately, this entails a stable ratio of public debt to national income.

But where should this ratio be set?

Back in the 1990s, the European union set a target rate of 60 per cent of national income. At the time, with bond interest rates around 5 per cent, that implied annual interest payments equal to 3 per cent of national income. Taking account of inflation at 2 per cent, the value of payments required to hold debt constant in real terms was about 2 per cent of national income. That’s easily manageable, but still a significant component of government budgets (it’s more than most spend on defence, for example).

Repeating the same calculation today causes some problems. The real rate of interest on high grade sovereign bonds is now negative [That’s true even distressed borrowers like Greece. That is, bondholders are paying governments for the privilege. So, the more debt governments issue, the more they receive.

And there is, it appears, no real limit. Japanese government debt is equal to more than 200 per cent of national income. But 5-year government bonds yield negative returns, just as they do in Germany. Even bonds with a term of 30 years offer interest rates below 1 per cent, below the current rate of inflation.

The bigger question is: in the absence of any apparent constraint on our ability to finance current spending with long-term debt, what policy approach should replace the now-discredited goals of balanced budgets and zero debt. The answer is to consider fiscal policy in terms of the need to match aggregate demand (public and private) with the productive capacity of the economy, taking account of the appropriate balance between consumption and investment.

This way of thinking about things comes naturally to old-school Keynesians,

This suggests a policy of matching the maturity of financing public spending with the effective duration of that spending. Current expenditure, such as transfer payments, should, under normal conditions, be financed by taxation. Long-term investments in physical, human or social capital should be financed by bonds with a maturity similar to that of the investment’s lifetime. This approach is broadly consistent with the accrual accounting framework introduced in the 1990s, but left to languish as governments returned to a focus on misleading, but seemingly more comprehensible cash-based measures.

If this approach is adopted consistently, the long-term equilibrium will be one in which the ratio of public debt to GDP will be determined by the stock of public investments in physical and human capital.

23 thoughts on “Public debt after the pandemic

  1. I think its important to talk about the difference between Q.E. and direct social spending via deficits. Q,E. is a gigantic confidence trick undertaken to avoid giving poor people money. Instead it gifts rich people money, a little indirectly, in the form of massive, low interest loans. Specifically, it gives bankers and shareholders access to low interest and no interest loans to pump up asset and share prices. Little. if any. of this gets back to poor people. It also does little to promote productive investment.

  2. Unless I’m missing something, 3 – 2 = 1 in most jurisdictions.

    The discuss=sion basically ignores the topic of the book, viz. the pandemic. The debt incurred is not a long-term investment but a response to a shock out of the blue. At the end of it, we will at best be back to the status quo ante, minus a lot of deaths and the pile of debt. Formally, it looks very like the wars that led to the British debt mountains: 260% or 290% of GDP in 1815 (estimates of GDP vary), ca. 160% in 1918, 240% in 1945. Only the first had an economic benefit – half a century of global hegemony and a boost to manufacturing technology – and that’s a stretch. Japan’s contemporary 200% in contrast was just unsuccessful peacetime pump-priming. You need a paragraph on Acts Of God.

    In the general case you have a legacy debt that is in large part the random result of acts of God: wars, pandmics, and financial panics. The null hypothesis is that debt mountains from these make little difference. The British government in 1815 was a pure night-watchman state, without even a police force. The landed oligarchs who ran it liked things that way, debt or no debt. I suppose British policy in the 1920s was too consevative partly out of debt concerns, but it wasn’t these that led to the return to the gold standard.

    The big caveat is that the debt mountain has to be held by nationals. Foreign borrowing is dangerous at far lower ratios, espcially if it’s short term and has to be rolled over at intervals. (The British debt in 1815 was almost all perpetual, making a bond panic a negligible risk.) JQ’s audience is international and the qualification is essential.

    The proposed rule (borrowing = public investment) looks arbitrary. Education is an investment in the future. To a large extent, so is ante-natal and child health care. Should they be funded by borrowing?

    I’m not sure we need a rule at all. Japanese borowing has just been responding to short-term macro concerns. Like Topsy, the debt just growed. Disaster has not ensued, nor is it on the horizon.

  3. Unless some of this huge debt is not see aside to plan for the next pandemic, and prepare long term development of hospital and medical services, then it is an unwelcomed burden. Social costs must always be considered. You have thousands of people whose long term health has been damaged by COVID-19. That means that the “old normal” of decreasing, in real terms, public expenditure on health is not an option for the future.
    Yet politicians will see all this extra money as an opportunity to spend up big on unnecessary projects in their own electorate. This was done before the pandemic, but must be clamped down on after the final wave, if that ever comes. As Keynesians are wont to say, its not the amount of money borrowed that matters; its what that borrowed money is spent on that decides the efficacy of public debt. Matching debt periods to usage is only the first step. Professor Quiggin is right to say that transfer payments should be funded by annual taxation receipts. Yet this is not always the case. It is like the PIGS situation during the Great Recession, where politicians had recklessly borrowed money before 2008, o much so that they had made it impossible to borrow money after 2012.
    Fiscal discipline must not be abandoned just because surplus units want governments to protect their money. The rich can look after themselves. Lets not fall into the trap of the money economy where the wishes of the rich override the needs of everyone else. .Big business must not be giving any public money. Struggling politicians must not be allowed to use borrowed money to get reelected. Any of this new money must be directed towards sustainable economic development. The fact that it is currently “free money” means nothing. Our future health relies on building more public hospitals not giving tax concessions so that a private company can build a hospital then make huge profits.
    If we do borrow big then there is no excuse for starting right now to build many more hospitals. And for not designing them better so that when the next health emergency arrives, there will be large isolation wards and stockpiled protective gear. If this is not done now it never will be done; as politicians return to their lazy way of wasting money that is not there’s to waste.

  4. James @2 Great minds think alike. I’ll be covering lots of the topics you mention, including perpetual bonds, education investment, legacy debt and more.
    If possible with extracts like this, I’d prefer comments on what’s in the extract, rather than on what isn’t (but may be coming later).

  5. I am in no state to make a comment for which I could possibly take responsibility the night after. Before it is too late to write anything, I’d like to thank JQ for his work and I’d like to wish him and all readers of his blog a Happy New Year, to be defined by each person according to his/her preferences with one rather safe to assume common factor – an end to this pandemy. In the meantime, stay safe and happy

  6. I appeal to the bylaws of the Critics’ Guild (for those who failed entry into the Assassins) which clearly state that members “have an inalienable right, established beyond peradventure by centuries of practice, to hold an author to account for the work they didn’t write.”

  7. I should specify that the entry examination for the Assassins’ guild has three sections: theory, character, and a physical for strength and dexterity. Pass 1, fail 2 and 3, and you can head for the Crime Writers’ Guild. Fail 1 and pass 2 and 3, and a reasonable career in the Henchpersons’ Guild awaits. Pass 1 and 2 and fail the physical, and it’s the Critics’ Guild as I said. Pass 1 and 3 and fail 2, your best chance is Captain Vimes and the Watch. They do pay a pension to dependants if you are killed in the performance of your duties, a significant risk..

  8. “Book-in-progress assassins are the worst.” – J.Q.

    For the last book and this book of J.Q’.s, I have probably been a “book-in-progress you-need-to rethink this substantially nagger” rather than a book-in-progress assassin, I hope. Nevertheless, with awkward expression of ideas and lack of tact, one can start sounding very much like the other.

    I try to be more careful now. However, my extreme exasperation and white-hot anger with neoliberal capitalism rises ever higher at its manifest and existentially murderous idiocies. It is too easy then to spray the fire everywhere and to alienate potential allies and like-thinkers. Sooner or later I should crawl under a rock and shut up, perhaps before my Ischemic demyelination becomes too bad. It’s a real thing and I’ve got some. But then many people my age do. In other words, I must plan to disappear from blogs before it becomes florid emeritus blogger disease.

  9. Happy New Year
    Am i glad to see that MMT becomes more of a norm today, but sad to know that soon after the pandemic all will be forgoten and MMT will be out of favor again.
    Also sad to see that still there is no understanding of full implications of present discourse and understanding of public debts and not considered.

    “But where should this ratio be set?” (public debt to income ratio)
    “And there is, it appears, no real limit”
    That should have been clear since Keynes, yet it is becomming understood just now in pandemic, barelly recognized durring GFC. Shame. It used to be understood only when it comes to war funding.

    So, do not worry about public debt levels but what it is used for and how.

    “The answer is to consider fiscal policy in terms of the need to match aggregate demand (public and private) with the productive capacity of the economy, taking account of the appropriate balance between consumption and investment.”
    In 2017 the Fed was calculating that US economy was producing 1.2% over capacity and started raising rates. It took them a whole year to realize how wrong was their calc on capacity.
    COnclusion is that a roductive capacity can not be measured untill inflation shows up.
    SO, the measures of productive capacity should go the way the public debt/ ncome ratio went. Forget such useless term, please. It is not measurable untill you have inflation.
    Balance between consumption and investment. What is that? Consumption can not be controlled. DO you want to?
    Investments are per a need of society and economy not per a financial constraints as concluded earlier, so why look for some imaginary balance?

    The sentence should go “The answer is to consider fiscal policy in terms of the need to match agregate demand with the employment levels and energy capacity of the economy.” the rest of your sentence is just a usuall gibberish in accordance with neoliberal and mainstream dogma that is fully cracked and exposed as ideology not economics.

  10. The Councils of the Assassins’ and Critics’ Guilds, in a rare joint statement, firmly reject the suggestion that work to discredit a book-in-progress is in any way equivalent to a regulation attack on a published work. With the latter, the author is stuck with their printed words, typos, grammatical solecisms, errors of fact, misattributions, pages bound upside down, and accidental inclusion of pornogaphic illustrations involving camels. They can always walk away from any part of a work in progress, or indeed abandon the whole thing. The guild fee scales in force reflect this disparity.

  11. I am totally ignorant of what you are describing but it put an image in my pea brain of a man with two wallets. One in the right pocket and one in the left pocket. He takes money out of the right pocket and puts it in the left pocket then takes money out of the left pocket and puts it in the right pocket.

  12. mamikie,

    You have just summed up macroeconomics. I await your summary of microeconomics. 🙂

  13. I remember in the late 1970s, when I did my graduate economics program, that people were building macroeconomic models with steady-state rates of inflation. The idea that inflation would be brought under control seemed inconceivable then although most of us had one foot in the monetarist camp – we half-believed that the stock of money growth determined inflation at least in the long run – so controlling monetary aggregates would help – at least in the long-run. Much of this thinking has been proven wrong by the march of events. Macroeconomics is necessarily built on strong assumptions and often with an unreasonable fixation on current events. In the late 1970s, we were trapped by the aftermath of the oil price shocks.

    I think that ideas about optimal debt should incorporate a healthy dose of modeling uncertainly particularly with respect to the implicit idea that capitalism is slowly dying (or experiencing secular stagnation) and that low inflation rates, and therefore low nominal interest rates can be sustained indefinitely. A sustained spurt of inflation might follow the ending of the virus threat and an improved global situation with respect to China. It might also follow a reluctance by borrowers to hold increasingly risky amounts of public debt.

    The precautionary principle might suggest keeping public debt at moderate levels. That might mean being able to finance public debt interest payments at much higher interest rates that prevail at present due to a reemergence of inflation or by the looming recognition by lenders that their debt holdings have insecure valuations because of the prospects of public debt defaults at higher interest rates.

  14. As always, I find I half agree and half disagree with the better (in my eyes) conventional economists. But first I will get one point noted and quickly put aside. Monetarism was and is anathema in my eyes. Milton Friedman I regard as an out and out charlatan.

    I strongly agree that capitalism is slowly dying via, at this stage, secular stagnation and other issues; except for China of course but their time will come soon enough. Capitalism is not dying for the reasons theorized by the old orthodox Marxists. It is not due to the tendency of the rate of profit to fall (TRPF). That is pure dogma held by some old school Marxists and TRPF is refuted by the real trajectory of profits in modern capitalism. Marx famously said, “All I know is that I am not a Marxist.” In Marx, the TRPF is theorized as a tendency not a law and he noted counter-tendencies. There was no implication that the TRPF would prevail endogenously as a long term trend. Marx also noted the final dialectical result that his own labor theory oif value would fail to automation (machine automaticity which replicate and replace physical and intellectual labor. See the “Fragment on Machines” from Grundrisse.

    The secular stagnation of developed nations is more due to the tendencies to over-production, automation, profiteering, financialization, corporate tax avoidance and the forced decline of wages. via global labor arbitrage. The Western “aristocrats of labor”, meaning the Western workers, were paid well in the Golden Era of Western capitalism, as an accommodation for being compliant with the capitalist bargain; this during the stage of colonialism and imperialism. The super profits stolen by empire (eg India under the British Raj) were used for capitalist superprofit and to boost western worker wages. This cosy arrangement ended with the end of colonialism, empire and (earlier) odious forced trades like slavery and the opium trade. This ended via third world independence, development, the shift of manufacture and the exploitation of third world environment and labor. This really explains why China is dynamic and the West stagnant.

    However, soon enough, climate change and climate change driven disasters [1] plus the real limits to growth will enforce stagnation and then collapse on the entire global economy. That conventional economists still want to fuss (sorry, it has to be said) about the “theory” of debt (a notional problem) in the face of all the coming real problems is diagnostic of their inability to focus on the empirically real. The jigging or rigging of the notional only matters insofar as and as long as the notional precepts of capitalism are upheld. Abandon them, for something more real and equitable in political economy and the system-prescribed existence of debt and its consequent formal problem to real problem progression could be melted away.

    Of course, I doubt anybody in the silo of conventional economics will pay the least attention to such theory backed as it is by the historical empirical record. No, it’s much better to have neat, formal, mathematicized and totally unempirical theories about notional social fictive quantities and treat them as measuring real things.

    [1] COVID-19 is actually a climate change driven or climate-catalyzed disaster. In turn climate change is a capitalist system driven disaster (including the state / oligarchic capitalisms of totalitarian Russia and totalitarian China).

  15. Jure Jordan “It is not measurable until you have inflation”. But inflation is neither uniquely defined nor easy to measure. It can mean consumer price inflation (full of measurement problems), wage inflation (mixes real wage growth with inflation) or asset price inflation (already evident). In addition, quite a few MMT advocates, having pointed to inflation as the measure of excess demand, then propose all sorts of schemes to hold down the measured rate of inflation.

  16. True that inflation is wagely defined and not easy to measure.
    The same is true of productive capacity measure of an economy.
    Consclusion is that any notional target is a uselles task, how ikonoclast nicely described, and should stay with a real target like full employment.
    Do not worry about the public debt levels but about private debt levels.
    To help with private debts, the inflation (wage inflation) is a debt burden reducer. I think it is a neccssity for a debt economy. For many other reasons but burden reducer as the main one is that inflation target should be around 4%.
    The free lunch that inflation offers to debtors was, to me, the main obstacle to finally understand MMT workings. Knowing from the personal experience that income renumeration is allready arbitrary (there is barely any meritocracy) helped me to accept that more arbitrary effects of inflation is normal and a necessity. There is a uselles task of making income renumeration more fair and to concentrate on more macro then micro issues. MMT insights then fell in place for me, once i have quit false moraiizing about world injustice.
    Nominal targets should not be considered as usefull, nor taken as control variable. Nor inflation nor productive capacity.

    The problem of inflation control as presently institutioalized is that everybody knows that it is a fiscal policy issue yet attempts to control it is a monetary policy. Do you see the problem?
    As the present configuration of controlling inflation works, comercial banks were supposed to follow the official interest rate and offer it to the economy. Yet they do not follow. COmercial banks do not offer bellow 3.5% interest to the economy at large (yes there are some speialized niche targeting where they do offer such low rates but not to the economy at large) but official rate is going even bellow 0%. Because the economy can not have the rates that are officially targeted and other issues like loan terms is why monetary policy can not work in most of the conditions. So, MMT offers variety of solutions that might be problematic.

  17. Respectfully, I would say that it is somewhat nieve to state that there is an “absence of any apparent constraint on our ability to finance current spending with long-term debt”.

    It is possible to for a central bank to create electronic representations of money on a screen, but you can’t digitally create natural resources, energy or productivity. Money can be seen as a representation of work with debt a promise to pay someone with future work. Under normal market conditions without the government digitally creating so much money, you would be seeing a rise in interest rates. These policies will dilute the value of dollars in circulation throughout the economy and will affect poorer people more than the rich, as those with assets will be protected as they rise in nominal value while the value of dollars declines (why the US stock market is currently at record highs while the real economy and small business are collapsing). Many grain prices are up ~50% this year while oil is hardly down despite the largest demand destruction in history. This disproportionally affects poorer people while those close to the digitally created money benefit eg. government employees/contractors, banks, large corporations etc.

    We are reaching the limit of any benefit to new debt in “advanced” economies since there are diminishing returns the more you create and they will largely require money printing to back them. That’s why we’re likely to see stagnation at best going forward in Australia, Japan, Western Europe, North America etc.

    Might be worthwhile considering the following quote from Keynes:

    “Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

    Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become “profiteers,” who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

    Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

    If you read Karl Marx or Alan Smith, they both understood that to grow an economy long-term you need to produce savings to accumulate capital.

    Britain was able to bring down it’s large debt from the Napoleonic war because they went through the process of an industrial revolution where there were huge productivity gains from burning coal. Regardless of how hard a horse or agricultural labourer works, you can’t match the productivity of industrial machinery, which is why their economy grew so much in the 19th century and they developed a large empire.

    Unless some kind of new energy source is discovered with a higher energy return than oil (highest density energy source we’ve ever discovered), it’s unlikely this debt will ever be able to be repaid. If anything the opposite is likely, as cheap sources of energy are increasingly being depleted and remaining sources will be more expensive to extract with lower returns.

    Proponents of MMT (like those who claim that we can run our entire modern society on solar panels and wind turbines) are basically religious believers who have not studied the facts in detail. Some time this century we are looking at a much smaller global economy and probably a much smaller global population as well – whether we like it or not and regardless of how many digits central banks create on computer screens.

  18. @David
    “It is possible to for a central bank to create electronic representations of money on a screen, but you can’t digitally create natural resources, energy or productivity.”
    What do you need to create resources, energy or productivity?
    Human labor, some resources and …”electronic representations of money on a screen”
    You need those electronic screen money to pay labor and resource to create more. You need it to organize labor to create, can’t do without it. At the present such electronic money is locked in wealthy accounts and they claim that there is no productive investment opportunity. They also claim that state also has no money to help such organizing to produce. Yet it is so simple to create such electronic money and organize production.
    Yet you have neglected last 150 years of monetary developement when you wrote your comment.
    Please update your economics for last 150 years.

  19. Sure Jordan. There are an infinite amount of natural resources in the world that can just be released by central banks creating digits on a screen. Infinite amount of oil that will never increase in cost to extract like deep water and fracking. Infinite amounts of copper to produce electric cars – mines will never need to go deeper and the resources will never become more expensive to extract since we will never deplete any existing resources.

  20. Will public debt continue to support this? Great quote, imho, for your book JQ…
    “ancillary to the financial transaction it enables — a trend across the whole economy, where the selling of goods or services serves to enable the collection of data, the absorption of venture capital funds or the levying of hidden transaction fees.”

    Who knew airlines are banks, and mint their own money tokens? I’m a bit slow. Almost a book – article on…

    “The Man Who Turned Credit-Card Points Into an Empire

    “A major reason points-and-miles trips exist is because airlines turn a more stable profit by minting their own currencies than by selling actual airline seats. The flight seems almost ancillary to the financial transaction it enables — a trend across the whole economy, where the selling of goods or services serves to enable the collection of data, the absorption of venture capital funds or the levying of hidden transaction fees. In this scheme, posting to social media, or collecting points and miles, or ordering a taxi or a gyro on your phone, is merely a gesture to keep the whole process in motion. The real moneymaking happens behind the scenes, driven by a series of exchanges where value seems conjured from nothing at all.

    “But of course, value always comes from somewhere. If you trace the thread back on any one of these businesses, it’s always the same deal: The poor underwrite the fantasies of the middle class, who in turn underwrite the realities of the rich. When credit cards charge high interchange fees, they pass the cost of loyalty programs on to merchants, who in turn pass it back to customers by building the fees into their sticker prices. Those who pay with credit can earn it back in points. Those who pay with debit or cash wind up subsidizing someone else’s free vacation. According to a 2010 policy paper by economists at the Federal Reserve Bank of Boston, the average cash-using household paid $149 over the course of a year to card-using households, while each card-using household received $1,133 from cash users, partially in the form of rewards. It remains a regressive transfer to this day.”…

    It is school hols and it seems I have lots of reading time. I stop soon.

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