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The Economist April 25th 2020 Briefing Covid-19 and public finances 15
2 creases that would pay for more spending cies and other immaterial products.
on the National Health Service even before No sign of a ceiling 1 Even without a mechanism for keeping
the pandemic struck. Ageing populations Gross government debt as % of GDP interest rates low, inflation can go some
are also increasing the demand for public Advanced economies Forecast way to lessening the debt burden. “My gut
spending, as are investments needed to 120 instinct is that we will need higher infla-
tackle climate change. Reinhart and Rogoff* tion to wash away some of the debt,” says
The second option—defaulting or re- IMF† Maurice Obstfeld of the University of Cali-
90
structuring debts—may be forced on to fornia, Berkeley (who, like Mr Blanchard
emerging economies which lack any other and Mr Rogoff, was once chief economist at
60
way out. If it is, that will cause significant the imf). Yet though inflation may be nec-
suffering. In advanced economies, though, essary if debt burdens are to shrink, it may
30
such things have been increasingly rare not be readily forthcoming. A few econo-
since Keynes’s day, and look unlikely to mists think inflation will surge of its own
0
make a comeback. A modern economy in- accord when the enormous economic
tegrated into global financial markets has a 1900 20 40 60 80 2000 20 stimulus they expect butts up against the
huge problem if capital markets lock it out Sources: Reinhart and Rogoff, *Simple average, 22 countries supply disruptions imposed by lockdowns.
2009 and updates; IMF †Weighted average, 39 countries
as a bad risk. But Mr Obstfeld and many others worry in-
That said, there may be more than one stead about deflation, or at least less infla-
way to default. Kenneth Rogoff of Harvard this “financial repression”. tion than they would like.
University argues that promises to in- In a paper published in 2015, Carmen For some, the cause of this is “debt over-
crease health-care and pension spending Reinhart of Harvard University and Belen hang”—the idea that debts sap the econ-
in coming decades should also be viewed Sbrancia of the imf calculated that France, omy of demand. Wealthy bondholders, by
as government debt of a sort, and that this Italy, Japan, Britain and America spent at definition, prefer saving to spending.
sort of debt is easier to back out of than ob- least half of that period in so-called “liqui- Many others make a simpler judgment. The
ligations to bondholders. It is hard to ascer- dation” years in which interest rates ad- circumstances of the pandemic which
tain whether the “default” risk in these justed for inflation were negative. They es- made massive borrowing necessary in the
debts—ie, the risk that politicians cut timated that the average annual first place—such as surging unemploy-
health-care and pension spending, reneg- “liquidation tax” to governments resulting ment—are also likely to cause a deflation-
ing on their promises to ageing popula- from real interest kept low by inflation and ary slump. Since the pandemic started, the
tions—is rising. Unlike bonds they are not financial repression ranged from 1.9% of cost of insuring against inflation through
traded on financial markets that provide gdp in America to 7.2% in Japan. financial markets has fallen, reflecting a
signals of such things. But it almost surely belief that there is unlikely to be much of it
is, especially in countries, like Italy, where The violence inherent in the system about. Investors seem to be predicting that
pension spending is already enormous. To attempt such repression today, though, five to ten years from now the Bank of Ja-
Rich-country politicians unwilling to would require redeploying tools used by pan, the European Central Bank (ecb) and
shift away from spending and towards tax- post-war governments—tools such as capi- the Federal Reserve will all be undershoot-
ing, or to risk finding out how terrible a de- tal controls, fixed exchange rates, rationed ing their inflation targets.
fault would be, are likely to choose to grow bank lending and caps on interest rates. Low inflation is bad for nominal
their way out of hock. The secret to this is This would be offensive to lovers of eco- growth. But it does at least reduce borrow-
ensuring that the economy’s combined nomic freedom. It would also be suffi- ing costs. Central banks can cut interest
level of real economic growth and inflation ciently contrary to the interests of inves- rates, if they have any room left to do so,
stays handily above the interest rate the tors and savers to be politically very and create money with impunity. In the
government pays on its debt. That allows demanding. That said, the coming years five weeks leading up to April 16th, the Fed
the debt-to-gdp ratio to shrink over time. could prove to be politically demanding bought $1.3trn of American government
In a much-noted speech in 2019 which times. But if governments did enact such debt: 5.9% of 2019 gdp and more than the
called for a “richer discussion” about the changes, they would spur responses un- entire budget deficit.
costs of debt, Olivier Blanchard of the Pe- available to investors of the 1950s and Thanks in part to the Fed’s actions, the
terson Institute for International Econom- 1960s, such as investment in cryptocurren- American government can borrow for ten 1
ics, a think-tank, argued that such a strat-
egy was more plausible than many might
think. In the United States, he pointed out, The scope of the problem 2
nominal growth rates higher than interest Gross government debt as % of GDP, 2019
rates are the historical norm. of which held by: Central banks Foreign creditors Forecast
Many rich-world governments pursued Other domestic creditors increase in Likely central- Nominal GDP Ten-year
Offset by government financial assets bank purchases 2015-19, government
this sort of strategy after the second world ratio in 2020 in 2020* % increase† bond yield‡, %
0 50 100 150 200 250
war with some success. At its wartime
height, America’s public debt was 112% of Japan 15 15 1.5 -0.01
gdp, Britain’s 259%. By 1980 America’s Italy 21 7 1.9 2.03
debt-to-gdp ratio had fallen to 26% and
US 22 10 4.1 0.63
Britain’s to 43%. Achieving those results
involved both a high tolerance for inflation France 17 6 2.4 0.14
and an ability to stop interest rates from Spain 18 7 3.8 1.08
following it upwards. The second of these
Canada 21 9 2.9 0.61
feats was achieved by means of a regulatory
system which, by depriving citizens of bet- Britain 10 9 3.5 0.34
ter investment options, forced them in ef- Germany 9 5 3.3 -0.39
fect to lend to governments at low interest
Sources: Debt management offices; central banks; IMF; The Economist *Of government bonds, as % of GDP †Annual average ‡Latest
rates. By the 1970s economists were calling