Even before the pandemic, the federal budget deficit was approaching record levels and adding significantly to the nation’s debt burden. The economic stimulus bills since passed have been a lifeline to many but were financed with trillions of dollars of debt. According to projections, the ballooning deficit is projected to grow the national debt from 79 percent of GDP before the crisis to around 130 percent of GDP by 2030.
But, according to Harvard economists Larry Summers and Jason Furman, there has been a shift in the fiscal paradigm. The new paradigm suggests that public debt isn’t a major problem and that government borrowing for the right purposes is actually prudent. Here is why: Interest rates are much lower than they were in the past and are expected to stay low for years to come.
A key indicator is the real interest rate, which is a better measure of true borrowing costs than the actual or nominal rate. The real rate — the interest rate minus inflation — has been generally less than 1 percent, and often negative, over the past decade. Why? Because corporations are flush with cash and savers with few options are willing to buy government debt even with low interest rates.
As a result, the burden of debt on taxpayers isn’t what it used to be. Before the pandemic, federal debt as a percentage of gross domestic product was twice its level in 2000. But federal interest payments as a percentage of GDP were actually down. In fiscal 2020, the U.S. government borrowed a massive 15 percent of GDP, yet the 10-year government bond still paid less than 1 percent. The likelihood is that low rates will continue well after the pandemic ends.
A Furman-Summers research study determined that the burden of debt is best measured by annual inflation-adjusted interest payments as a percentage of GDP and that anything under two percent should be sustainable. At present, it is well below that. Furman recently said that far from burdening future generations, the government has a golden opportunity to fund long-standing needs.
The biggest long-term need is addressing climate change, which in itself could cost in the trillions. Either we address climate change now or pay a lot more later. Bill Gates recently wrote that as awful as this pandemic is, climate change could be worse. It is a clear and costly danger facing the world. Inventing and implementing solutions will spur a torrent of innovation and will create an enormous number of lucrative jobs.
Summers is against the part of Biden’s plan that gives $2,000 in stimulus money to most citizens. It is not needed because the great majority of workers are employed and so putting additional money in their pockets could overheat the economy. He recommends borrowing money for infrastructure spending to be done in a “green” framework.
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So, when will we reach a “debt ceiling”? The markets will inform us by raising interest rates and dropping the value of the dollar significantly. Such shifts do not happen in a vacuum. Inflation expectations would have to rise, which economists say is unlikely. We might experience a (very) short-term blip in inflation as the world gets vaccinated and pent-up demand get released.
So, what can go wrong? A sequence of events that nobody can imagine or anticipate — the proverbial unknown, unknowns. That risk can be alleviated by locking in low interest rates with 30-year bond issues. According to The Economist, the average maturity of U.S. Treasury debt is 63 months. It seems prudent that future bond issues be lengthened to 30 years, which are yielding less than one percent on a real interest rate basis. It is almost free money. So, let’s strike while the iron is hot.
Lastly, the GOP needs to temper its opposition to deficit financing when a Democrat is president. A reminder that during Trump’s pre-pandemic tenure, the fiscal deficit was increased by 60 percent. And the tea party had mutated into the Lunesta Party. It needs to remain in hibernation.
Murad Antia teaches finance at the Muma College of Business, University of South Florida, Tampa. In a former life he was a quantitative equity manager at a major bank in Florida.