Jhe coronavirus pandemic has wreaked catastrophic havoc on the economy, with unemployment in April 2020 increases faster than any month on record. The Treasury responded with unprecedented measures to support workers, businesses and the self-employed, resulting in a public deficit of 300 billion pounds sterling This year.
How worried should we be about public debt, which is expected to exceed the size of the UK economy? Public debt occurs when the government spends more than it collects in tax revenue – runs a public deficit – and borrows money to cover the difference. The government then pays interest on this debt, which is ultimately repaid or renewed by new loans. As long as interest rates are low – they are currently close to zero – there is little cost. The economy can also grow, generating more tax revenue and making debt repayment easier. But if interest rates rise faster than economic growth, public debt can reach unsustainable levels. These may eventually require budget cuts or tax increases, often referred to as austerity.
The Center for Macroeconomics (CfM) – a research center bringing together experts from institutions such as the London School of Economics, the University of Oxford, the University of Cambridge and the Bank of England – posed this question to a panel of some of the UK’s leading economists. Economists are pretty conservative: we like budget numbers to add up. So the answers might surprise. With one exception, not a single panel member expressed concern about the deficit. What’s more, the majority believed that public debt should ultimately be addressed through tax increases, especially on the wealthy; and the panel unanimously opposed government spending cuts. Many even advocated monetary financing of the deficit, that is to say the direct sale of government bonds to the Bank of England. Nowadays, even economists do not support austerity.
These views are a far cry from the calls for budget cuts during the global financial crisis and reflect a substantial shift in economic thinking that has taken place over the past few decades. Change is not just a British phenomenon. German economists have been particularly intransigent on limiting deficits during the eurozone crisis. Corn a new generation of German economists has been at the forefront of promoting “coronabondswhich would pool the debts of EU members. The International Monetary Fund (IMF) was well known for its conservative views on government deficits. The global financial crisis brought changes to the institution, with its then chief economist, Olivier Blanchard, openly advocating stimulus rather than austerity.
Economic stabilization through government spending was the brainchild of John Maynard Keynes during the Great Depression. But the Keynesian moment in economic thought was relatively short-lived. The global inflation of the 1970s brought a new generation of economists, skeptical about the ability of governments to use their fiscal power to support economic recovery. Keynesian views had been pushed back so far that the Nobel Prize-winning economist Robert Lucas Jr. pronounced “the public begins to whisper and giggle to each other” whenever Keyensian views were adopted in economic research seminars.
These views infiltrated political consciousness to the point that in 1976 Prime Minister James Callaghan told the Labor Party Conference that the option to “spend[ing] come out of a recession and increase[ing] jobs by cutting taxes and increasing public spending” no longer existed and would only lead to inflation. These opinions were recorded in the Washington Consensuswhose first principle, according to John Williamson, was: “Washington believes in fiscal discipline”.
The public debt debate resurfaced during the 2008-9 recession. A sizable faction of the economics profession continued to warn that fiscal stimulus was not a way to recovery. At the same time, a growing number of mainstream economists, including IMF management and Ben Bernanke, then head of the United States Federal Reserve Board, backed public spending expansions undertaken by the US government and warned that the UK’s austerity program would deepen the economic crisis. The change in attitude was partly pragmatic. By the turn of the century, many economists had come to believe that central banks had the ability to solve all macroeconomic problems. This position became less tenable when central banks around the world ran out of ammunition, having cut interest rates to zero.
The slow recovery in the UK and the economic carnage in southern Europe – both as a result of austerity policies – compared to the faster recovery in the US, seem to give more credence to the idea that active fiscal policy could be used to support economic recovery. This new vision may have peaked in Blanchard’s 2019 presidential run. address to the American Economic Association, where he argued that public debt is no longer a concern when interest rates are well below the growth rate of the economy. Our confidence that high-income countries, which are still able to borrow at low interest rates, will be spared may be premature. Public debt is indeed not a concern when interest rates are at zero. But history shows us that government borrowing rates can change drastically when market sentiment changes.
Benign neglect of the deficit is ultimately a luxury for rich countries. The developing world is now in the midst of the greatest public debt crisis in one generation. From Argentina to Zambia, governments are financing their deficits with great difficulty. As investors repatriated their funds to the relative safety of the United States, these countries have seen their borrowing rates rise and their currencies fall, and will need (or are already in the process of) restructuring their debt.
Governments’ top priorities must remain the public health emergency and supporting the economy in these difficult times. But it would be wise to keep half an eye on the public debt clock.
