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Most major economies have substantial government debt; for example among the OECD countries the lowest debt rate is Estonia with around 6% of GDP. Now we may be in a global recession at the moment, but even during the more prosperous times of the twentieth century most countries maintained substantial public debt. Here is a graph of the US federal debt:

A graph of the US federal debt as a percentage of GDP since 1940

And here is one of the UK's national debt:

A graph of the UK's natioanl debt as a percentage of GDP since 1692

(Both graphs via Wikimedia.)

What benefits do governments of advanced economies receive from not eliminating their debt?

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    $\begingroup$ I think this is a good question. I think there is an efficient level of debt, greater than zero. I will leave answering the question to someone a bit more skilled at this stuff. $\endgroup$ – Jamzy Nov 19 '14 at 4:25
  • $\begingroup$ Governments? Not much. Political parties don't want to solve this long-standing and not very popular problems so they rather wait until someone else will solve it for the next 5 years (this applies especially for the Europe where the number of political parties is (luckily) still bigger than 2). $\endgroup$ – Probably Dec 23 '15 at 14:13
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Most of the same considerations apply to countries as apply to businesses and people, plus a couple of extra cons

Pros of Being Debt Free

  • No interest payments
  • Not beholden to someone else (financial freedom)

Cons of Being Debt Free

  • Buying things on (interest free) credit can save a little money
  • Paying for things in installments can match costs to income
  • Interest rates can be used to control economic activity and defend currency
  • Having a bond market promotes domestic financial activity
  • Having government bonds provides savers with a safe investment

There is big difference between having no debt and having no net debt. In the former case, you do not borrow any money and that is rare. In the latter case you have the money but choose to borrow instead. Many individuals do this by spending on credit card even though they have money in the bank, or not paying off all of their mortgage because the interest rate is good (so they can earn more with their money elsewhere).

For governments there are extra benefits from having debt (even if you can pay it off).

Perhaps the best way to understand this though is to look at a few notable examples, past and present.

US 1836

If you don't set interest rates, someone else will

The Federal Reserve was only established in 1913, prior to that the US had an uneasy relationship with the concept of central banking.

It seems the founding fathers were against central banking, and it wasn't until Alexander Hamilton that "First Bank of the United States" was created in 1791, mandated to last for 20 years, after which it's mandate was not renewed.

Second Bank was established in 1816. Andrew Jackson was strongly against central banking (and banking generally!) and so when he came to power in 1832 he pulled the state money out of the bank. The bank countered by tightening money supply to push the economy into recession. Andrew Jackson held out and paid off the entire national debt by 1836. The Second Bank did not have it's chartered renewed, and liquidated in 1838.

With no debt, and no central bank the US money supply was effectively free. Jackson also introduces the Specie Circular which required all government land be purchased in gold and silver. The rest of the 1830 saw significant inflation and recession, generally attributed to Jackson defeating the central bank.

The US government had lost control of their own economy, and in 1837 the Bank of England raise rates, forcing up domestic US interest rates, precipitating the 1837 panic. The following years were marked by major recession.

For more on this see: WDJ article on US debt and Wiki: Second Bank

Norway Today

Keep some debt for liquidity purposes and financial control

Norway currently has around \$170bn of public debt, with a GDP of about \$500bn. However in 1990 the government established what is now called the "Government Pension Fund of Norway" into which the excess income from Norwegian oil is poured. It is an equity and bond portfolio currently estimated to be worth in excess of \$700bn.

The government of Norway could choose to pay off all its debts easily, but chooses not to. Instead they maintain issuance in sovereign debt markets in order to hold a liquid reserve to cover their daily payments. They also mention using the money to "develop well-functioning and efficient financial markets". A final consideration in their case is that their assets are abroad, and repatriating them would weaken the Krone, so there is some FX consideration here.

Because of this, it is not surprising that Norway has a AAA credit rating, and that also makes it cheaper for Norway to borrow than even the US (based on 5Y CDS).

For more on this see: Norway Ministry of Finance and Norges Bank

Singapore Today

Issue debt to give people something to invest in

Singapore has had no foreign debt (ie. non-SGD) since 1995, and consistently runs with a fiscal surplus. Despite this they issue T-Bills and Notes of various maturities consistently and simply invests the proceeds.

Why? According to the Monetary Authority of Singapore (MAS) the main objectives are:

  • Provide a liquid investment alternative with little or no risk of default for individual and institutional investors;
  • Establish a liquid government bond market, which serves as a benchmark for the corporate debt securities market; and
  • Encourage the development of skills relating to fixed income financial services available in Singapore.

For more on this see: MAS MoneySense

North Korea

If you don't pay, its not really debt...

This is only a semi serious one, but one country that basically has no debt is North Korea, for the simple reason that no-one will lend to them. They do technically have debts though, including a debt to Sweden for some Volvos, but in 1984 they defaulted on them all and refused to pay anything. It seems they have no-intention of ever paying. I don't think I need to explain the downsides to the North Korean approach to economics.

See: North Korea's Stolen Volvos

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  • $\begingroup$ So it sounds like there are many benefits to public debt, but that debt doesn't necessarily need to be government debt (ie, due to budget deficits). $\endgroup$ – curiousdannii Nov 19 '14 at 11:52
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    $\begingroup$ It is still government debt - it just isn't NET debt. It is like if you have the cash to buy a house but take out a mortgage anyway, because you want to keep the cash invested say. $\endgroup$ – Corone Nov 19 '14 at 12:04
  • $\begingroup$ Ah, North Korea... For a while their chief exports were Nuclear Secrets and counterfeit dollars. Impressive! $\endgroup$ – Steve S Nov 19 '14 at 14:23
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    $\begingroup$ Any feedback on the downvote? $\endgroup$ – Corone Nov 21 '14 at 15:39
  • $\begingroup$ It will be interesting to note how closely the collapse of North Korea comes to the point in time when those thousand 1974 Volvos stop running. $\endgroup$ – Bob Stein Jan 10 '16 at 19:55
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There is an interesting report that circulated during the Clinton administration, when we predicted we'd pay off all the debt, that I think answers your question. (here's a public radio article about it)

The main takeaway is that government bonds are the safest and most liquid asset. Its existence is necessary for a large number of financial institutions (think insurance companies, pension funds and postal savings) and important as benchmark elsewhere.

Moreover the report suggests that monetary policy would be harder without government bonds. The Fed would have to buy stocks or corporate bonds instead but most markets are simply too small to accommodate the Fed's needs. This would mean that any open-market operation by the central bank would produce large swings in the relative prices of financial assets with unknown consequences.

Luckily we never paid it off.

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  • $\begingroup$ The bonds market is just the current transmission mechanism. Before that monetary policy was conducted through banks. Its existance might be convenient but not necessary. $\endgroup$ – s_a Nov 19 '14 at 13:37
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    $\begingroup$ That part about pension funds, insurance companies, etc. should be emphasized--longer term bonds (like the 30-year T-bond) are 1.)hugely important for building portfolios that can match their liabilities and 2.) have become more scarce as the commercial bond market has become more homogeneous (their trend has been towards shorter term securities, i.e. 10-year issues). $\endgroup$ – Steve S Nov 19 '14 at 14:30
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Suppose your country holds debt equal to thirty percent of GDP and that the government is obliged to pay interest of five percent per year on that debt. This implies that each year the cost of servicing the debt is 1.5% of GDP. Thus, if the country's GDP grows at a rate of 1.5% then it can afford to service the debt indefinitely without the debt/GDP ratio growing. If the country's economy grows at a rate greater than 1.5% per annum then, even if the government only pays the interest on the debt, the size of the public debt will be shrinking relative to the rest of the economy. If you believe that people have some sort of diminishing marginal utility of income then it is likely to be the case that the optimal strategy is to postpone some fraction of the debt repayment until such a time as the country is richer (and people face a smaller marginal dis-utility of giving up the income needed to pay down the debt).

Even putting aside the political expediency of postponing debt repayment, paying off the debt can be postponed until the country is 'richer' and therefore better able to do so.

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    $\begingroup$ That's an important point but the plots in the question already use the debt-to-GDP ratio so increases in nominal debt are not what the question is about, increasing debt-to-GDP ratio is. $\endgroup$ – Relaxed Sep 30 '15 at 6:43
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I am quite surprised that none of the answers above have mentioned the classic Barro article "Are Government Bonds Net Wealth"

The way I understand it is that given that the utility function is increasing and concave in consumption, increasing consumption increases utility but at a decreasing rate. Using the same logic, decreasing consumption decreases utility at an increasing rate! So, you can think of this in a representative consumer's framework- the marginal costs of increasing taxation are increasing. If the government wants to expend money for a certain project- building a damn for instance- many fixed costs have to be borne immediately. In order to not tax the public all at once, they smooth out taxation- providing the service while at the same time not making the consumer pay all at once. There is a side of the argument that the governments have a comparative advantage in providing loans compared to, for ex, banks. So, in effect, they take out a loan in the name of the public at lower interest rates.

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In moderate amounts, debt is a stimulus. That is, if a country spends 105 percent of its GDP instead of 100 percent, it will grow faster, and over time, the "extra" growth will be sufficient to pay off the debt, and leave the country ahead of where it would be without the debt.

The danger is that if total debt becomes too high (say 100 percent of GDP), its marginal productivity declines as the required rate of interest rises. Moreover, it makes the country vulnerable to external macroeconomic "shocks" like rising oil prices.

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  • $\begingroup$ There is nothing specific about 100% of GDP or any other threshold. The total level of public debt is not what determines whether additional debt will produce “extra growth”. $\endgroup$ – Relaxed Sep 30 '15 at 6:49
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From a political standpoint, debt is less contentious than taxes.

From an economic standpoint, in a fiat currency deficit is equal to an increase in the money supply, and can be used as a bridge between fiscal and monetary policy to stimulate growth. As older debt retires, this could lead to a stabilizing, or even temporary reduction in nominal debt load.

Lastly, externalities like decreased economic output during a recession would increase the debt to GDP ratio as depicted by those charts.

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  • $\begingroup$ I don't know if this really explains much. If a debt was being deliberately maintained at a stable level then it wouldn't involve either a deficit or an increase in taxes to pay off. $\endgroup$ – curiousdannii Nov 19 '14 at 5:39
  • $\begingroup$ those charts didn't look stable to me. :) Except maybe the projection at the end for the US. $\endgroup$ – Jason Nichols Nov 19 '14 at 5:40
  • $\begingroup$ fair point :P But for short parts they're somewhat stable, such as the US from 1974-1982. That's 8 years, and I'd guess it would've had a few government changeovers in that time. $\endgroup$ – curiousdannii Nov 19 '14 at 5:42
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    $\begingroup$ I don't know enough either to have much opinion! Let's see what others say. $\endgroup$ – curiousdannii Nov 19 '14 at 5:46
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    $\begingroup$ "in a fiat currency deficit is equal to an increase in the money supply" can you justify that statement? $\endgroup$ – Corone Nov 21 '14 at 10:19

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