Wednesday, May 24, 2023

Rethinking fiscal rules

Public debt ratios have risen since the Covid shock as governments sought to cushion the impact of the shock. Global debt to gdp averaged 96 per cent in 2021. The average for advanced economies was 120 per cent. In 2008, after the Global Financial Crisis, the numbers were 64 per cent and 79 per cent.

The general view, articulated by the IMF, is that the rise in public debt was inevitable and desirable. But… it needs to be brought down quickly. That is, of course, the received wisdom taught in all Macroeconomics courses, namely, the lower the public debt, the better.

It is refreshing to hear a different view from Andy Haldane, former Chief Economist of the Bank of England. Haldane makes two interesting points. One, over centuries, global debt to gdp has tended to rise as governments respond to the need to create more and more public goods. Two- and this is very interesting- even as public debt has risen, the interest costs have fallen. Not quite what you the Macro course would tell you.

How do you explain these? Well, public debt is used often to create assets. These assets generate streams of income over time that can service the debt. So lenders to government look, not just at the debt, but at the assets that the debt creates. What matters thus is not public debt per se but net worth of government, that is, assets minus debt.

Recognising those assets would give us a measure of the true net worth of the government. Just as a company or household would look at their net worth when making investment choices, so too should government. Countries with high net assets have been found to have lower borrowing costs. Bond market vigilantes target poor ancestors, not borrowers.

Moral of the story? The need to create important public goods remains, perhaps, including those relate to climate change. No need to panic over rising debt levels- focus on debt sustainability. As long as debt creates productive assets, physical or human, chances are debt will be sustainable.


No comments: