The real debt problem

7 Apr, 2019 at 19:00 | Posted in Economics | 4 Comments

The ad nauseam repeated claim that our public debt is excessive and that we have to balance the public budget is nothing but absolute nonsense. The harder politicians — usually on the advice of mainstream establishment economists — try to achieve balanced budgets for the public sector, the less likely they are to succeed in their endeavour.darling-let-s-get-deeply-into-debt And the more the citizens have to pay for the concomitant austerity policies these wrong-headed politicians and economists recommend as ‘the sole solution.’

One of the most effective ways of clearing up this most serious of all semantic confusions is to point out that private debt differs from national debt in being external … A variant of the false analogy is the declaration that national debt puts an unfair burden on our children, who are thereby made to pay for our extravagances. Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our children or grandchildren and to nobody else. Taking them all together​ they will no more be impoverished by making the repayments than they will be enriched by receiving them.

Abba Lerner The Burden of the National Debt (1948)

Few issues in politics and economics are nowadays more discussed — and less understood — than public debt. Many raise their voices to urge for reducing the debt, but few explain why and in what way reducing the debt would be conducive to a better economy or a fairer society. And there are no limits to all the — especially macroeconomic — calamities and evils a large public debt is supposed to result in — unemployment, inflation, higher interest rates, lower productivity growth, increased burdens for subsequent generations, etc., etc.

But the truth is that public debt is normally nothing to fear, especially if it is financed within the country itself (but even foreign loans can be beneficent for the economy if invested in the right way). Some members of society hold bonds and earn interest on them, while others have to pay the taxes that ultimately pay the interest on the debt. The debt is not a net burden for society as a whole since the debt cancels itself out between the two groups. If the state issues bonds at a low-interest rate, unemployment can be reduced without necessarily resulting in strong inflationary pressure. And the inter-generational burden is also not a real burden since — if used in a suitable way — the debt, through its effects on investments and employment, actually makes future generations net winners. There can, of course, be unwanted negative distributional side effects for the future generation, but that is mostly a minor problem since when our children and grandchildren ‘repay’ the national debt these payments will be made to our children and grandchildren.

To both Keynes and Lerner, it was evident that the state has the ability to promote full employment and a stable price level – and that it should use its powers to do so. If that means that it has to take on debt and (more or less temporarily) underbalance its budget – so let it be! Public debt is neither good nor bad. It is a means to achieve two over-arching macroeconomic goals – full employment and price stability. What is sacred is not to have a balanced budget or running down public debt per se, regardless of the effects on the macroeconomic goals. If ‘sound finance,’ austerity and balanced budgets means increased unemployment and destabilizing prices, they have to be abandoned.

Discussing within which margins public debt is feasible, the focus today 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.

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.

To view government debts in terms of the ‘functional finance’ concept introduced by Abba Lerner, is to consider their role in the macroeconomic balance of the economy. In simple, bare bones terms, the function of government debts that is significant for the macroeconomic health of an economy is that they provide the assets into which individuals can put whatever accumulated savings they attempt to set aside in excess of what can be wisely invested in privately owned real assets. A debt that is smaller than this will cause the attempted excess savings, by being reflected in a reduced level of consumption outlays, to be lost in reduced real income and increased unemployment.

William Vickrey


  1. The most powerful predictor of unemployment is a multivariate regression with total private debt plus its time derivative, credit. This accounts for 90% plus of variance in unemployment. The sweet spot apparently is total private debt to GDP equal about 0.7 and credit equal approximately to GDP growth.
    We are now at total private debt of about 150% of GDP. Credit growth seems healthy but that raises many questions.
    For me the question is how do we return the post WWII sweet spot? Sector balance says fiscal deficits must produce private surplus. But how do we know private surplus won’t simply create new collateral for even greater credit expansion by chartered banks, which integrates up to even higher total private debt to GDP ratio? During WWII, government ran huge deficits but simultaneously imposed war rationing. It was culturally uncool to finance consumption of goods and services. It was cool to buy war bonds or to quietly pay down debt with higher servicing costs than war bonds. Total private debt to GDP fell quickly from 160% of GDP to 50%. What is the MMT explanation of how we get to the sweet spot without these other two policy and cultural legs?

    • Public debt is required to retire private debt and to net save. This means that higher ratios of private debt and wealth accumulation should produce public debt increases as well to maintain stability and prevent default levels that threaten the private sector. GDP growth obscures this simple truth by allowing private debt to be “rolled over” into that growth, creating increased fragility in the business cycles. Driving higher levels of private debt by limiting public debt is good for banking – – – until it isn’t.

      While it wouldn’t be difficult to project what level of public debt is needed, most would assume that increasing it when demand for private debt is also high would be inflationary. If spending was properly managed to increase productivity and security proactively the demand for private debt would decrease until equilibrium with the ability to retire that debt was reached. It is only debt, both public and private, generated for unproductive use that would create inflation. Bond issues to satisfy the desire of the private sector to save would be generated proactively as well, reducing rent-seeking investments.

      Our current attitude toward public debt makes it mostly reactive to the economy via automatic stabilizers and that results in a roller coaster of booms and busts for workers. Those at the bottom often never recover their ability to advance because of the loss of credit and resources.

      • Great comment. My big question is: Given there are many policy driven routes to total private debt reduction, which path is “best”. Here, best means; least disruptive to growth, least conducive to unemployment, most encouraging for innovation and productivity growth, most environmentally sustainable, least wasteful of resources and so on.
        We know one solid example that was a mixed bag but obviously was largely successful. That would be WWII.
        While it was obscenely wasteful of resources, both men and material, we suppressed consumption by war rationing plus appeals to patriotic support for war effort. We ran enormous fiscal deficits producing great private surplus financial wealth accumulation. We offered govt bonds at an interest yield that was low so debtors chose to directly deleverage rather than buy treasuries and use the coupon to continue servicing their debt. This combination of incentives drove private debt down quickly and dramatically.
        Steve Keen proposes a deficit financed debt Jubilee where govt insists and private surplus go toward deleveraging. In post war Germany, Allied command declared all private debt null and void, daring rich ex Nazis to complain.
        History teaches that either an existential threat, like war, or an occupying force, is required to impose the discipline to deleverage rather than to use such surpluses as collateral for even more private debt. The problem isn’t inflation. The problem is too high private debt per se. the servicing of private debt diverts capital away from productive enterprise and fair wages to labor, into the banking and finance sector.

    • Lots wrong with this post. First we should not be using the GDP but rather the GPI — Genuine Progress Indicator. Secondly war bonds were used to make the debt an asset of the people as well as withdraw money from an economy possibly facing inflationary pressure. Finally the planet’s carrying capacity is being exceeded in several respects and its ability to provide a decent standard of living is falling short of wha it should be. Budgets and monetary policy should have clear goals and values within a framework that makes sense.

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