2
$\begingroup$

I have a question about the greater severity of large national debt caused by borrowing from foreign sources.

I am reading a book about elementary Economics and am currently on a chapter discussing the strengths and weaknesses of demand-side policies.

The book (A-level Economics, Anderton, 2015, pp. 204) states the following:

Keynesian economics states that so long as a government can print money to finance its deficit without fueling inflation or borrow money from the financial markets, then the National Debt is not a problem for the short term. Nearly all economists, however, would argue that, in the long term, large National Debts can be a problem particularly if they are financed mainly by borrowing money from foreigners.

However, I am struggling to understand how they can be worse than borrowing from domestic debt markets (if I have stated the correct market i.e. from a domestic lender).

My understanding was that if the debt was financed through printing more money, and had to pay off the loans to a foreign lender, it would find it harder to reduce the supply of money via reversing quantitative easing i.e. selling bonds back into the bond market, so impending inflation in the long term would occur.

However, the book does not qualify its statement regading large National Debt as above so I am not sure what the justification is for Anderton's statement above.

Why would large National Debts financed by foreign lenders be a greater problem than domestic lenders if the problem was to be solved by printing more money?

$\endgroup$
1
$\begingroup$

The statement should be ideally subjected to several caveats because there is a lot of heterogeneity between how difficult it is to manage external debt among nations (e.g. developed vs developing nations, country in monetary union vs country outside monetary union etc), but generally it is argued that:

  1. Foreign debt is usually (but not always) also denominated in foreign currency. In the past sometimes people even used words 'foreign debt' and 'debt denominated in foreign currency' interchangeably (Vasishtha, 2007) even though that of course is not accurate as you can have foreign debt denominated in domestic currency, and domestic debt denominated in foreign currency. Still just the fact that some scholars sometimes slipped and used the terms interchangeably indicates that often foreign owned debt is denominated in foreign currency. Such debt is more difficult to manage because it can't be easily monetized.

  2. Foreign and domestics creditors are different, for many countries, foreign investors will be large international hedge funds or other governments or international organizations like IMF, whereas domestic creditors are typically domestic firms or individuals. It is easier for large international organization to try to sue government, or to do reputational damage to the government which will make its future borrowing costs higher (Vasishtha, 2007).

    On the other hand, domestic creditors are at the mercy of the government. Since from creditor's perspective the government debt is an asset, government can always decide to raise taxes on the income domestic creditors earn from these assets (thereby recouping portion or all interest paid on the domestic debt), or levy some wealth tax that will in effect force domestic creditors to in effect hand portion of their assets (and debt is an asset for creditor) to the government. To be fair in principle there are ways how domestic government can tax foreign entities as well but it's much more difficult (see discussion of that in Gros 2011).

$\endgroup$
1
  • $\begingroup$ Such discussions should be at the cornerstone of some of these textbooks. I think this is an excellent answer and I'm glad to give it an upvote and tick. Appreciate it! Thanks, @1muflon1. $\endgroup$
    – vik1245
    Aug 16 at 15:56

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.