MARK THOMA,
The Fiscal Times
February 26, 2013
As we head into yet another self-inflicted crisis over the national
debt, does the potential harm from the debt justify the risky
political tactics and potentially harmful brinksmanship that Republicans have
used in negotiations over the debt ceiling, the fiscal cliff, the sequester,
and whatever might come next? Is it possible that the artificial crises that
Republicans have created during these negotiations pose a much greatest risk to
our future economic growth than the debt itself?
It’s not only possible, it’s highly likely. Let’s begin with
the economics. There are two main ways that government debt can cause economic
problems. First, an increase in government debt can increase borrowing costs
for everyone in the economy through the usual operation of supply and demand.
The interest rate is the price of borrowing money, and when the demand for
loans increases because the government is borrowing more, the price of loans –
the interest rate – goes up.
This reduces spending on investment, consumer durables,
housing, and other interest sensitive purchases, and the lower level of
investment reduces future economic growth. But there are also benefits. An
increase in deficit spending increases output and employment, and when the
spending is on items such as infrastructure there is the further benefit of an
enhanced potential for economic growth.
Near full employment, the benefits of deficit spending are
generally low and the costs are generally high, so this type of spending can be
problematic, but the reverse is true during severe downturns. In a deep
recession when people are struggling to make ends meet, the increase in output
and employment from an increase in deficit spending is very valuable. At the
same time, the costs are very low since there is usually an excess supply of
funds – the money piling up in bank vaults and corporate coffers is an example
of this – and government borrowing simply soaks up this excess, it does not put
upward pressure on interest rates as it does near full employment. This makes
it very likely that deficit spending in a deep recession will be a net
positive, even more so for infrastructure spending due to its ability to
increase our capacity for future economic growth.
The second potential problem is what a recent paper calls “tipping point dynamics.” In tipping point models, there
is a threshold debt to GDP ratio of 80 percent to 90 percent. When
economies cross this threshold interest rates can shoot up quickly and cause a
government funding crisis and the potential for sovereign default. Thus,
economies with debt levels in excess of the threshold can suddenly be thrown
into turmoil and recession, and if this happens the result is unambiguously bad
– there are no benefits to trade against lower future growth as there were in
the case discussed above.
Republicans have been highlighting the possibility of
interest rate spikes and sovereign debt default, it’s an opportunity to force
spending cuts and realize their goal of a smaller government and lower taxes on
the wealthy, but the risks aren’t anywhere near as large as we’ve been told. To
see this, it’s important to separate countries like Greece and Italy who must
repay their debt using currencies they don’t control from the countries like
the US that have their debt denominated in their own currency.
Our debt is a promise to pay dollars, and unless we run out
of trees for paper money or the electrons needed for digital money, we can meet
those obligations. So long as creditors know they will get the money they are
promised, the incentive for speculative runs that can cause so much trouble for
a country like Greece is all but eliminated (and there is evidence supporting this view). This is not a recommendation to pay our debt
by printing money, not at all – there are costs to this approach – it’s an
explanation of why the fears of spiking interest rates and default on the debt
differ substantially depending upon whether a country controls its own
currency.
The fears of a sovereign debt promoted by those with other
agendas are very much overblown. We have the economic resources we need to pay
our bills, we’ve managed just fine with even higher debt burdens in the past,
and as a last resort we can always print the money we need to meet our
obligations. The real question is whether our politicians and political
institutions are up to the task they face, particularly today’s Republican
Party. Unfortunately, the answer suggested by the negotiations over the debt
ceiling, the fiscal cliff, and the sequester is not encouraging.
If we have a crisis, the ability to pay our bills will not
be the problem. It will be caused by politicians on the right gambling with the
economy, and an inability to pull back from the brink of a self-inflicted
crisis created in pursuit of political and ideological goals.
