No, We Don’t Have to Pay Back Government Debt

Peter Dorman attacks the shibboleth that simply will not die:

No it doesn’t. It almost never is. To pay back government debt, you have to run a budget surplus, and while there may be modest surpluses from time to time, they don’t add up to more than a minuscule fraction of all the accumulated debt….

The story is unmistakable: the US jacked up its public debt to finance WWII and increased it further in almost every year since then. We are not paying off the debt left by our parents and grandparents, and our children and grandchildren will not pay off ours.

Dorman explains what is required:

The debt burden depends on the ratio of debt to GDP as well as the interest cost in servicing it. The way to reduce this burden is to have a combination of real economic growth, inflation and modest interest rates. If you want to show your solicitude for the well-being of future generations, demand macroeconomic policies that will boost demand and raise inflation a bit, consistent with continued low interest rates.

This is something I discussed in in detail:

So what do we mean by ‘unsustainable?’ Typically, it’s colloquially used to mean ‘really big and scary’, but that’s not something very measurable. Economist Willem Buiter, former adviser to the Bank of England, argues that sustainability in the context of deficit reduction is best thought of as a stable GDP-debt ratio: that is, relative to the size of the economy, the public debt does not increase. Seems reasonable.

I’ll leave out the equations (although the math is not very difficult), and proceed straight to the key points. First, Galbraith shows that if the inflation-adjusted interest rate (the ‘real’ interest rate) on the public debt is greater than the real growth rate of the economy, debt is unsustainable. The trajectory of that instability can vary, but it doesn’t who you are, the GDP-debt ratio is going to rise.

Second, the converse is true: when the real interest rate is lower than than the real growth rate (or, even better, negative), the GDP-debt ratio will eventually become stable. Where it stabilizes will depend on the particulars, but it will stabilize. Under that scenario, we are not DOOMED!!

Keep the economy growing, and interest rates at where they have been for most of the post-WW II era, and we’re fine. And always remember there’s a difference between a currency issuer and a currency user.

Sadly, Dorman was correcting a NY Times economics reporter….

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2 Responses to No, We Don’t Have to Pay Back Government Debt

  1. Joe Shelby says:

    Well, as I commented on that page, I respect the term “reasonable interest rates”, but I don’t think they are right now. I think they are unreasonably, unrealistically too low. They are free money from the feds which is encouraging what could only be described as laundering by the banks, and they are too low for the banks themselves to actually make a profit doing real “bank stuff” (like making loans to small businesses). The loan rates are so low that the profits from successful loans simply can’t cover the losses from unsuccessful loans, so the banks simply aren’t loaning to ANYBODY, and are making their money solely from the same Wall Street-level gambling they were doing before, plus the laundering mentioned above, plus the standard big-corporation practice of layoffs and consolidations. Nothing has changed because there is no profit in going back to what it should be, and it will always be that way when home loans are 3%, small business loans are 5, and the Feds continue to give away (our) money for free.

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