Thursday, May 02, 2013

Should governments spend even when debt is high?

We have been following the RR debate in these posts. The latest twist is a seeming softening in the RR position in a recent FT article.They suggest that a stimulus might still be worth it in the present situation of high debt provided it goes into infrastructure:
A higher borrowing trajectory is warranted, given weak demand and low interest rates, where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower.
Government of India, please note. Here, the concern is not so much the debt to gdp ratio but high inflation and a high current account deficit. But if these two indicators are showing signs of coming under control, a case for public spending in infrastructure could arise. Let's face it: in the run-up to elections, private investment simply won't revive, so any impetus to growth can come only from public spending. Absent growth, all debt indicators will rise and pose risks of a rating downgrade.

RR also make a case for higher inflation as a way to bring debt under control:
One of us attracted considerable fire for suggesting moderately elevated inflation (say, 4-6 per cent for a few years) at the outset of the crisis. However, a once-in-75-year crisis is precisely the time when central banks should expend some credibility to take the edge off public and private debts, and to accelerate the process bringing down the real price of housing and real estate.
This point is also worth pondering in India. Our debt to gdp ratio has declined, contrary to trends elsewhere, thanks to high inflation. We need to bring inflation down to 6% or so but leaving it at that level should be ok. RBI seems to have accepted this de facto, but is yet to accept it de jure. The reality is that we do have a 'new normal' for inflation; might as well acknowledge it.

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