We hear a lot about the scourge of government debt in our current political discourse, but I wonder about the economic veracity of these claims.
To my mind, this issue shouldn’t be reduced to the simplistic binary of debt-is-good vs bad. With unemployment rates above 6 per cent the Australian government should surely focus on stimulating the economy, there’s a very real risk that cutting spending could slow it down.
To try and get to bottom of this division I’ve dug up a number of articles (by economists far more eloquent than I), which do a great job of dissecting the structure of public debt and its effects on Australia’s growth prospects.
To begin with, some figures. The 2014-15 Budget Papers stated Australia had a debt-to-GDP ratio of 12.5 per cent for 2013-14, rising to 13.9 per cent in 2014-15. This figure is useful for making comparisons between countries and, most notably, Australian debt levels are low when compared to other developed nations. This ratio compares the size of the debt to the sum of Australia’s productive output.
Greg Jericho in The Guardian explains some drawbacks to the debt to GDP ratio as an indicator, focusing on the fact that the government’s income is far less than the Aussie GDP as a whole. He explains that debt-to-government-revenue comes in at a more telling 54 per cent for 2013-14.
Bonds, debt and growth
The bulk of Australian debt comes from the government selling bonds. This is done by the Treasury, which “issues” the debt instrument for a set period of time and with a set amount of interest. For those buying bonds it’s a low risk place to park your money.
Now don’t get me wrong, I’m a capitalist and I appreciate the importance of a budget surplus, but I see it more as a sign of a strong economy rather than an ambition. Right now is surely not the best time to kill consumer confidence with austerity.
Right now debt is cheap; the ten-year bond rate is around 2.5 per cent, we only need to invest in projects that pay returns higher than 2.5 per cent per year and we’re ahead! We most likely won’t see money that cheap for a very long time, as Peter Martin laments in The Age, it’s “the deal of the century.”
The government must of course service the debt and it’s these interest repayments that form the oft-quoted figure of $1 billion a month. (The total face value of these bonds is currently worth a little over $300 billion.)
The government issues debt and spends the money on carefully chosen and economically efficient projects that help the Australian economy grow, well that’s the theory anyway. Excessive debt becomes a problem when it’s used for paying day-to-day costs, rather than investing in productive assets and programs.
Here we should remember the Reinhart and Rogoff debacle which shone a bright light on the question of whether public debt stifles growth. Reinhart and Rogoff argued yes, and their work was cited widely by “deficit-hawks”, but a scandal soon erupted when errors were found in their sums.
The Reinhart and Rogoff team didn’t back down despite a torrent of criticism, their refusal to recognize their critics drew the ire of commentators like Paul Krugman.
The R+R pair maintained their deficit-rage and published a report titled “Debt Overhangs” in 2012. The report maintained their argument that growth would turn negative when faced with “…prolonged periods of exceptionally high public debt, defined as episodes where public debt to GDP exceeded 90 per cent for at least five years.”
But as Krugman explained, the countries under the microscope had; “high debts as a consequence of their growth slowdowns, not the other way around.”
It’s all about inflation
In the Guardian, Warwick Smith explains that public debt is far less of an issue than the rhetoric would lead you to believe.
He argues that government spending now will not burden future generations with debt. Rather it is a government’s cuts to spending, or increasing taxes, to pay off debt that will reduce future generation’s standard of living.
The key point is that the ability of a government (with its own currency) to spend is not dependent on taxation revenue; instead, it is bounded by the inflationary impact of borrowing.
“If unemployment is the only price future generations pay for today’s government debt and the government can always lower unemployment by more spending, what’s the impact on future generations of government debt? None.” Smith says.
This is a vital point. In an economy with growing unemployment, government spending can stimulate growth. The spare capacity that exists (ie. unemployment) means there’s plenty of room for the government’s expansionary spending policies. Of course the borrowing/spending should stop when inflation pushes whatever limits are recognized as comfortable. The most recent figures for December 2014 show a slowing in inflation in Australia, the rate for last year as a whole was down to 1.7 per cent.
As was mentioned earlier, the allocation of borrowed funds is vital. Borrowing and spending will push up interest rates and inflation if productivity growth doesn’t keep up. We’ll remember Malcolm Turnbull’s criticism of Kevin Rudd’s second round of GFC stimulus. As explained in the Australian, he said he supported the first round, but the second round was too much.
Also stated in this article; “In the midst of the crisis, about four out of every five economists told this reporter the stimulus was “about right” in size.”
Whether Turnbull was correct or not, it demonstrates that there is a point at which borrowing becomes excessive and counter-productive. From what I’ve read, most commentators feel that Australia is not yet ready to see a slowing of expansionary fiscal policy, the focus should not be on paying off the deficit, it should be on reducing unemployment to drive growth. In turn, inflation will push higher and there will be no need for government spending.
Here’s a few extra links on the topic that you might find interesting…
Taxes for revenue are obsolete
This was written in 1946 by Beardsley Ruml, the Chairman of the Federal Reserve Bank of New York
Bundesbank: Money creation and responsibility.
An explanation of money in the modern world.
This guy called bonds in 2014, you listending this time?
The contrarian world of Steven Major
Been searching for a public debt overhang – didn’t get far
Bill Mitchell on the IMF’s austerity drive
Debt and (not much) deleveraging
McKinsey and Co offer a very thorough examination of where global debt stands today.