Public debt

1 Introduction

COVID-19 was designated as a pandemic in March of 2020 and recognized by governments as an all-hands-on-deck emergency. They responded by ramping up health spending, commissioning vaccine research, extending subsidies to employers seeking to meet payroll, and providing relief payments to households. They did this despite the fact that tax revenues were in sharp decline with businesses closed and residents locked down.

bond

A type of financial asset for which the issuer promises to pay a given amount over time to the holder. Also known as: corporate bonds.

How did governments accomplish this feat? Answer: they did so by borrowing. When governments spend more than they raise in taxes, they finance the difference by selling bonds to the public. Investors purchase those bonds with cash, which the government then uses to extend payroll subsidies, make relief payments, and finance other spending. Worldwide, on average, governments borrowed 10.2% of GDP in 2020 and an additional 7.9% of GDP in 2021. As they borrowed they became more heavily indebted. General government debt as a share of global GDP rose from 83.6% in 2019, on the eve of the pandemic, to an estimated 97.8% in 2021.¹ The extent of borrowing and increase in debt were unprecedented in peacetime. We would need to go back to the Second World War—an all-hands-on-deck emergency if there ever was one—to see anything similar.

interest rate

The price of bringing some buying power forward in time.

disposable income

Income available after paying taxes and receiving transfers from the government.

Few begrudge this borrowing. Governments that do not meet this kind of crisis by mobilizing additional resources, including those that can only be mobilized by incurring debt, face losing their legitimacy and public support. But now there is a financial legacy. There is a bill coming due. How should we think about this? When governments issue debt, they commit to paying interest to the bondholders and to buying back or replacing bonds when they mature. The spending happens today, benefiting the currently living, but interest and principal payments continue for as long as the bonds remain in circulation, potentially burdening successive generations. Thomas Jefferson, the third U.S. president, warned that ‘the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.’² Future generations must pay taxes to finance the state’s interest payments, leaving them less disposable income with which to put food on the table and invest in commercial and industrial ventures. Writing shortly before Jefferson, Adam Smith, in The Wealth of Nations, warned that these ‘enormous debts presently oppress, and will in the long run probably ruin, all the great nations of Europe.’³

countercyclical

Tending to move in the opposite direction to aggregate output and employment over the business cycle.

Smith and Jefferson are eminent figures, but not everyone shares their pessimistic assessment. Governments borrow for good reasons. They borrow to invest in roads, bridges, and broadband, and in so doing enhance the growth of the economy. They borrow to invest in early childhood education and technical training that make for a more productive labor force. Borrowing to finance these productive public investments bequeaths more debt and thus obliges households, now or in the future, to pay more taxes. But it also aims to deliver more robust growth and higher incomes, both topping up the government’s coffers and leaving those households better off even after paying taxes. In addition, governments, by borrowing, are able to boost public spending in periods when private spending is weak. They are able to engage in countercyclical fiscal policy, in other words, smoothing economic fluctuations.

To read a book-length discussion of these issues, see In Defense of Public Debt by Barry Eichengreen, Asmaa El-Ganainy, Rui Esteves, and Kris James Mitchener, or Sovereign Debt: A Guide for Economists and Practitioners by S. Ali Abbas, Alex Pienkowski, and Kenneth Rogoff. To read recent surveys that focus on debt crises in high-income and emerging economies, see ‘Sovereign Debt in the 21st Century: Looking Backward, Looking Forward’ by Kris James Mitchener and Christoph Trebesch, or ‘Enough Potential Repudiation: Economic and Legal Aspects of Sovereign Debt in the Pandemic Era’ by Anna Gelpern and Ugo Panizza.

In the Insight, we shall see that public debt is both a threat and an opportunity. It depends what it is used for and the circumstances in which it is taken on. The view from history tells us how and why governments have borrowed. Economic reasoning shows that the relationship between the economy’s growth rate and the interest rate explains the dynamics of the debt and enables us to understand the sustainability of the debt. From a political standpoint, we want to understand why governments repay what they borrow, in light of the fact that, as sovereign states, they are mostly immune from litigation in the courts. And we want to understand what happens when they choose otherwise.