Mar 7, 2019

Gravity applies to the debtgeist

Illustration: Aïda Amer/Axios

The law of gravity applies to the national debt after all: Inflation, interest rates and private investment can all still go awry given the wrong set of fiscal events.

What's happening: As we've reported (here and here), a number of mainstream economists and commentators have cast doubt on decades of orthodoxy that denounces the accumulation of government debt.

  • The new thinking urges that — for the moment, at least, and probably longer — we stop worrying about high inflation and interest rates, or crowded-out private investment, all of which textbook economic theory predicts when debt builds up.
  • That is, the government can add to the record $22 trillion debt without fear of igniting the demons that have warded policymakers off of big spending in the past.

But two leading mainstream economists who are part of the debt debate say that even though the old demons have not reared their heads to date, the danger of them surfacing remains.

Specifically, despite the U.S. possession of the global reserve currency — a central point cited by the pro-debt economists — it can't just spend using U.S. treasuries and never pay back what it's borrowed.

  • Larry Summers, a Harvard professor and former U.S. treasury secretary, co-authored an article in the current Foreign Affairs titled, "Who's Afraid of Budget Deficits."
  • Though Summers argues in the piece for smart and targeted deficit spending, he tells Axios that it has to be measured. The old rules still apply.
  • "We adopted the intermediate position, part way between the traditional advocates of austerity who think that debt is bad" and those who say you can spend as much as you like because interest rates and inflation are low. "You have to pay it back some day. If you borrow too much, you set the stage for hyper-inflation. We are for a balanced approach."

In a new piece at the Washington Post, Summers attacks adherents of "Modern monetary theory," who argue for extremely large new deficit spending.

No one knows where the trigger point is — which level of spending, or what set of events, will bring about runaway inflation, a surge in interest rates, or crowd out private investment, says Olivier Blanchard, former chief economist for the IMF and a senior fellow at the Peterson Institute.

  • In January, Blanchard surprised many of those who know him in a paper and speech that softened his prior attitude toward debt.
  • But, speaking to Axios, he said, "stuff happens" — that is, the economy can surprise. If U.S. interest rates surge higher than the GDP growth rate, for instance, that's a signal that debt is too high. Taxes would have to be raised to raise more revenue.
  • "But I don't have a clue what the right debt level is, only that we can go higher than we are," he said.

I asked Blanchard if you can finance the entire federal budget with debt, since interest rates and inflation seem under control. He calculated the outcome of such spending aloud, step by step, before concluding. "Nope. You would be crazy to go there."

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