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Public debt

4 The political economy of public debt

The recent upward trend of government debt as a share of GDP in the U.S. is part of a global trend evident in advanced (high-income), emerging, and low-income countries alike (as shown in Figure 3). Economists do not agree on what explains this trend.

There are three bar charts. Chart 1 shows data for advanced economies. The horizontal axis shows years ranging from 2007 to 2021, the primary vertical axis shows government debt as a percentage of GDP, ranging from 40 to 140, and the secondary vertical axis shows the interest expenses as a percentage of GDP, ranging from 0 to 5. Government debt has increased from around 70% of GDP in 2007 to over 120% in 2021, while interest expenses have fallen from around 2.5 to 1.8% in the same time interval. Chart 2 shows data for emerging economies. The horizontal axis shows years ranging from 2007–2021, the primary vertical axis shows government debt as a percentage of GDP, ranging from 20 to 70, and the secondary vertical axis shows the interest expenses as a percentage of GDP, ranging from 0 to 5. Government debt has increased from around 35% of GDP in 2007 to around 65% in 2021, while interest expenses have remained at roughly 2% over the same time interval. Chart 3 shows data for low-income developing countries. The horizontal axis shows years ranging from 2007–2021, the primary vertical axis shows government debt as a percentage of GDP, ranging from 20 to 70, and the secondary vertical axis shows the interest expenses as a percentage of GDP, ranging from 0 to 5. Government debt has increased from around 30% of GDP in 2007 to around 50% in 2021, while interest expenses have increased from 1% to nearly 2% in the same time interval.
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https://books.core-econ.org/insights/public-debt/04-the-political-economy-of-public-debt.html#figure-3

Figure 3 Interest expense and government debt, 2007–2021.

IMF Fiscal Monitor, April 2021. The blue bars plot government debt as percent of GDP (left scale) and the orange line plots interest expenses as percent of GDP (right scale).

Some see this increase in debt as a symptom of political dysfunction (for more details on how political interests can constrain governments and policymakers see Section 22.12 of The Economy 1.0). Casual observation and data suggest that political polarization, defined as the distance between the policy preferences of different political parties, is on the rise.1 2 When their spending preferences are very different—when polarization along this dimension is severe—the party in power will want to maximize spending on its preferred programs while in office, since it knows that the opposition will not continue those programs upon supplanting it. The party in power will be tempted to spend on its preferred programs whether or not the revenues are there.

For more details on ‘starving the beast’, you can read ‘Do tax cuts starve the beast? The effect of tax changes on government spending’ by Christina D. Romer and David H. Romer.

In addition, a political party that prefers low levels of government spending in general may rely on debt finance when in office in order to tie the hands of its successor. By requiring that successor to devote substantial resources to paying interest on an inherited debt, it can prevent it from devoting them to social programs. (This strategy, which increases reliance on debt finance by cutting taxes, is sometimes referred to as ‘starve the beast’.) Or the party in power may increase the deficit just prior to elections as a way of temporarily stimulating the economy and increasing its political chances.

Alternatively, what we see in Figure 3 might be efficient and rational. If interest rates on government debt decline, as they in fact have over the last four decades (see Figure 4), then it makes sense for governments engaged in tax smoothing to issue additional debt today, since the future taxes required to service it will be correspondingly lower.

In this line chart, the horizontal axis shows the years from 1980 to 2019, and the vertical axis shows the real interest rate, ranging from −2% to 7%. In high income economies, the real interest rate has fallen from over 6% in 1982 to −0.3% in 2019. In the U.S., the real interest rate has fallen from 2% in 2003 to −0.5% in 2012, then fluctuated at around 0–1% from 2013 onwards.
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https://books.core-econ.org/insights/public-debt/04-the-political-economy-of-public-debt.html#figure-4

Figure 4 Real interest rate estimated from inflation linked bonds in high-income economies and the U.S.

Rachel and Summers, 2019. The U.S. rate is based on treasury inflation-protected securities (TIPS). These are U.S. Treasury bonds that are indexed to inflation.

  1. Marina Azzimonti. 2013. ‘The Political Polarization Index’. Working Paper 13–41. Federal Reserve Bank of Philadelphia. ↩

  2. Robert B. Talisse. 2019. ‘Political Polarization is about Feelings, not Facts’. The Conversation. Updated 31 July 2019. ↩