On debt sustainability, functional finance, and the transfer problem

Here are some notes on public debt sustainability. Since WordPress apparently cannot tolerate equations I am forced to post the pdf version here and the introduction and main themes below: On debt sustainability

Anyone invested in Argentina right now will benefit from reading till the end.

More generally, feel free to dip in. Comments welcome.

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HOW OUGHT sustainability of public debt be assessed? And how should this assessment inform public taxation and spending decisions now and in future?

There are few questions of greater import in macroeconomics today. Yet answers remain elusive; often, discussions of fiscal policy are anchored by the need to attain a 60 percent debt-to-GDP ratio—or, more simply, the notion that public debt is too high. But why? What grounds are there for any debt target?

More worrying, perhaps, is the fact the international community struggles to understand lessons from the past decade. What is the correct stock of public debt? Why exactly was it necessary for Greece to default, but not Portugal? Is Argentina’s public debt today sustainable? We’ll get these questions.

Yet upon the opportunity to rethink debt sustainability analysis (DSA) in 2011, IMF staff acknowledged previous analysis “often turned into a routine exercise, with mechanical implementation of the DSA template, little discussion of DSA results, and limited linkages between the DSA and discussion of macroeconomic and financial policies” (¶2). At this crucial opportunity to fundamentally challenge and rethink sustainability—including key metrics such as the 60% debt-to-GDP target, the meaning of fiscal space, and the link between fiscal and external sustainability—the Fund doubled down on the pre-existing framework. We are stuck in the same old grooves of pre-crisis thinking.

That the framing of public debt and fiscal policy has barely moved on from a decade ago is a matter of huge concern. Absent policy tools following any near-future macroeconomic malaise, we ought carefully reassess our thinking. It is crucial we do not succumb to irrational fear of public debt; we need to sustain the flow of aggregate spending in the years ahead. We ought also educate the public against the false notion that public debt is always a burden—in fact, it can be a public good.

Unfortunately, economics lacks fresh thinking—groping in understanding, deflationary in mindset, atavistic in morality-of-debt thinking.

Fortunately, a conference in Washington, DC tomorrow offers an opportunity to set the record straight. Let’s pre-empt therefore five messages on public debt that ought emerge from this conference.

First, public debt need never be repaid.

Second, a 60% debt-to-GDP target is unnecessary, and for the public misleading.

Third, public debt reflects private savings.

Fourth, the complete, consolidated state balance sheet matters.

Fifth, sometimes the balance of payments matters most.

 

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