Public debt

10 Conclusion

Public debt allows governments to mobilize resources to meet emergencies, from wars, pandemics, and natural disasters to financial crises and recessions. Costs can be spread over time, avoiding the need to raise taxes to highly distortionary levels. Public debt issuance enables the government to finance productive investments that enhance the economy’s capacity to grow and that generate a stream of returns, enabling the Treasury to pay interest and repay the principal. A market in public debt allows the authorities to finance budget deficits in economic downturns. It allows them to use fiscal policy as a macroeconomic stabilization and insurance tool.

But public debt can also be issued imprudently to advance the private ends of those in power. Unproductive borrowing that does nothing to enhance the economy’s capacity to grow can be a burden on future generations required to pay additional taxes to service inherited debts. Incumbent politicians may borrow in order to boost spending just prior to elections and increase their political chances. A political party when in office may borrow to boost spending on its preferred programs, knowing that if it is supplanted by the political opposition no such spending will occur. Managing public debt poses a ‘common pool problem’. Each special interest favors issuing a little more to finance increases in its preferred programs without internalizing its contribution to the total debt burden.

Countries devise political and institutional mechanisms to restrain such behavior. They impose numeral limits for debts and deficits, incorporating these into statutory laws and constitutional amendments. They create independent government agencies to assemble and publish accurate data on the public finances, informing policy decisions. They constitute independent fiscal commissions to advise on fiscal choices. Such arrangements increase the likelihood that the government’s borrowing capacity will be used prudently. But they do not work perfectly, which is why public debt, unavoidably, retains its mixed reputation.