Should we worry about rising debt?
Stefano Schiavo argues that there are four reasons debt, this time around, is not as problematic as in the past:
- Central banks in advanced countries have already purchased large quantities of government bonds to provide liquidity to the banking system and stimulate the economy. Yet these interventions did not lead to increases in inflation;
- The price of oil, which has often contributed to fueling inflation in the past, is at record lows;
- Economic growth is expected to rebound in 2021 and the following years, but it will take a while before it reaches full speed;
- The cost of public debt (the interest rate paid by governments on government bonds) is very low for many countries (with some exception, Italy being the most relevant case in Europe).
Covid-19 Throws Us Into an Unprecedented Debt Crisis, But It’s One We Can Rise
By: Stefano Schiavo – Università di Trento
What can history teach us?
World War I was funded through borrowing, and much of that was eventually monetized by central banks. As the war ended the US and the UK pursued a balanced budget through substantial tax increases that choked off demand and triggered an exceptionally deep but short-lived recession.
Germany, on the other hand, fearing severe deflation, continued to spend on welfare payments and public-sector employment while relying on the central bank to do the financing. Germany’s policy response eventually produced hyperinflation, and much more profound social disintegration thereafter.
The Day After Tomorrow
By: Harold James – Princeton University
Large debt burdens lower aggregate demand
Mian and al. propose a theory of indebted demand, capturing the idea that large debt burdens by households and governments lower aggregate demand, and thus natural interest rates. At the core of the theory is the observation that borrowers and savers differ in their marginal propensities to save out of permanent income. They find that recent trends in income inequality and financial liberalization lead to indebted household demand, pushing down natural interest rates. Moreover, expansionary policies—such as accommodative monetary policy and deficit spending—generate a debt-financed short-run boom at the expense of indebted demand in the future. In this “debt trap”, debt-financed stimulus deepens the recession in the future, whereas redistributive policies and policies addressing the structural sources of inequality mitigate it.
Indebted Demand
Authors: Atif Mian, Ludwig Straub, Amir Sufi
From: Princeton University, Harvard University, University of Chicago
