The real public debt problem

21 Mar, 2019 at 09:17 | Posted in Economics | 1 Comment

The claim that our public debt is excessive has been used as a major justification for austerity – cuts in spending. That massive debt, we are told, 1) must be repaid, 2) threatens our country with bankruptcy, and 3) is a burden on future generations. All these are wrong. Let me explain why …

austerity-george-osborne-desktopBritain’s national currency is managed by our central bank, the Bank of England, owned by the citizens of the United Kingdom (that is, our elected government). As a result, the British government can never default on its bonds. Our government can replace maturing public bonds with new ones. Should private buyers, households and businesses, refuse to purchase the new bonds at the interest rate set by the British government, our government can sell them to the Bank of England …

The debt is nothing more than pieces of paper that the government promises to buy back on a specific date. These pieces of paper can be bought back with new pieces of paper (new bonds) with later buy-back dates. If the private owners of the debt paper do not want the new bonds (new debt paper), our government can sell those new bonds to the Bank of England for cash and use the cash to pay the bond holders.

John Weeks

Today there seems to be a rather widespread consensus of public debt being acceptable as long as it doesn’t increase too much and too fast. If the public debt-GDP ratio becomes higher than X % the likelihood of debt crisis and/or lower growth increases.

But in discussing within which margins public debt is feasible, the focus, however, is solely on the upper limit of indebtedness, and very few ask the question if maybe there is also a problem if public debt becomes too low.

darling-let-s-get-deeply-into-debtThe government’s ability to conduct an ‘optimal’ public debt policy may be negatively affected if public debt becomes too small. To guarantee a well-functioning secondary market in bonds it is essential that the government has access to a functioning market. If turnover and liquidity in the secondary market become too small, increased volatility and uncertainty will, in the long run, lead to an increase in borrowing costs. Ultimately there’s even a risk that market makers would disappear, leaving bond market trading to be operated solely through brokered deals. As a kind of precautionary measure against this eventuality, it may be argued — especially in times of financial turmoil and crises — that it is necessary to increase government borrowing and debt to ensure — in a longer run — good borrowing preparedness and a sustained (government) bond market.

The question if public debt is good and that we may actually have too little of it is one of our time’s biggest questions. Giving the wrong answer to it will be costly.

1 Comment

  1. The readers may wish to look at my following opinion pieces on similar issues. I have been advocating anti-austerity and exposing so-called expansionary fiscal consolidation myth since 2010.
    Is there an optimal debt-to-GDP ratio?
    https://voxeu.org/debates/commentaries/there-optimal-debt-gdp-ratio
    Rethinking Fiscal Policy for Global Recovery
    http://www.ipsnews.net/2016/06/rethinking-fiscal-policy-for-global-recovery/
    Unfounded Debt Fears Block Economic Recovery
    http://www.ipsnews.net/2016/06/unfounded-debt-fears-block-economic-recovery/
    Expansionary fiscal consolidation myth
    http://www.ipsnews.net/2016/08/expansionary-fiscal-consolidation-myth/


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