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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
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