FFor more than a decade, many economists – primarily but not exclusively on the left – have argued that the potential benefits of using debt to finance public spending far outweigh the costs associated with it. The idea that advanced economies could suffer from debt distress has been widely rejected and dissenting voices have often been ridiculed. Even the International Monetary Fund, traditionally a strong advocate of fiscal prudence, has begun to support high levels of debt-financed stimulus.
The tide has turned over the past two years, as this type of magical thinking collides with the harsh realities of high inflation and back at normal long-term real interest rates. A recent reassessment ” by three senior IMF economists highlights this remarkable change. The authors project that the average debt-to-income ratio of advanced economies will reach 120% of GDP by 2028, due to the decline in their long-term growth prospects. They also note that as high borrowing costs become the “new normal”, developed countries must “gradually and credibly rebuild their fiscal reserves and ensure the sustainability of their sovereign debt”.
This balanced and measured assessment is far from being alarmist. Yet not long ago, any suggestion of fiscal prudence was quickly dismissed as “austerity” by many on the left. For example, Adam Toozeit's 2018 book on the global financial crisis of 2008-09 and its consequences uses the word 102 times.
In fact, until recently, the idea that a high public debt burden could be a problem was almost taboo. Just last August, Barry Eichengreen and Serkan Arslanalp presented a excellent paper on global debt at the annual gathering of central bankers in Jackson Hole, Wyoming, documenting the extraordinary levels of public debt accumulated in the wake of the global financial crisis and the Covid-19 pandemic. Interestingly, however, the authors refrained from clearly explaining why this might pose a problem for advanced economies.
This is not just an accounting issue. While developed countries rarely officially default on their domestic debt – often resorting to other tactics such as surprise inflation and financial repression to manage their debts – a high debt burden is generally detrimental to economic growth. That was the argument Carmen M Reinhart and I presented in a short article for a conference in 2010 and in a more Complete analysis we co-wrote with Vincent Reinhart in 2012.
These articles sparked a heated debate, often marred by crude false declaration. This hasn't helped because much of the public has struggled to differentiate between deficit financing, which can temporarily boost growth, and high debt, which tends to have negative long-term consequences. . Academic economists largely agree that very high debt levels can hinder economic growth, crowding out private investment and reducing the scope of fiscal stimulus in the event of deep recessions or financial crises.
Certainly, in the era of extremely low real interest rates, before the pandemic, debt seemed truly free, allowing countries to spend now without having to pay later. But this spending spree was based on two assumptions. The first was that interest rates on public debt would remain low indefinitely, or at least increase so gradually that countries would have decades to adapt. The second assumption was that sudden and massive spending needs – for example a military build-up in response to foreign aggression – could be financed by taking on more debt.
Although some might argue that countries can simply dig themselves out of high debt, citing America's post-war boom as an example, a recent article economists Julien Acalin and Laurence M Ball refute this notion. Their research shows that without the strict interest rate controls imposed by the United States after the end of World War II and periodic inflationary surges, the US debt-to-GDP ratio would have been 74% in 1974, instead of by 23%. The bad news is that in today's economic environment, characterized by inflation targeting and more open global financial markets, these tactics may no longer be viable, requiring major adjustments to U.S. fiscal policy.
Kenneth Rogoff is professor of economics and public policy at Harvard University. He was chief economist of the IMF from 2001 to 2003.