The public debt ratio is of no concern because it falls once economic growth resumes.
Answer: False
The answer is False.
The public debt ratio is of no concern per se unless the government is using a foreign currency or is borrowing in a foreign currency.
Further, the primary deficit may not fall when economic growth is positive if discretionary policy changes offset the declining net spending as tax revenue increases and welfare payments fall (the automatic stabilisation).
Under current institutional arrangements, governments around the world voluntarily issue debt into the private bond markets to match $-for-$ their net spending flows in each period. A sovereign government within a fiat currency system does not have to issue any debt and could run continuous fiscal deficits (that is, forever) with a zero public debt.
The reason they is covered in the following blog posts - On voluntary constraints that undermine public purpose (December 25, 2009).
The framework for considering this question is provided by the accounting relationship linking the fiscal flows (spending, taxation and interest servicing) with relevant stocks (base money and government bonds).
From an ex post (after the fact) accounting perspective, the fiscal deficit in year t is equal to the change in government debt (ΔB) over year t plus the change in high powered money (ΔH) over year t.
The mathematical expression of this is written as:
which you can read in English as saying that Fiscal deficit (BD) = Government spending (G) - Tax receipts (T) + Government interest payments (rBt-1).
However, this is merely an accounting statement.
That means it has to be true if things have been added and subtracted properly in accounting for the dealings between the government and non-government sectors.
This framework has been interpreted by the mainstream macroeconommists as constituting an a priori (before the fact) financial constraint on government spending, which means they claim the government has to seek 'funding' from taxes or bond issues prior to spending.
But MMT informs us that a sovereign government is never revenue constrained because it is the monopoly issuer of the currency.
The way the mainstream macroeconomics textbooks build their narrative is to draw an analogy between the household and the sovereign government and to assert that the microeconomic constraints that are imposed on individual or household choices apply equally without qualification to the government.
The framework for analysing these choices has been called the 'Government Budget Constraint' (GBC) in the literature.
The mainstream shift, without explanation, from an ex post sum that has to be true because it is an accounting identity, to an alleged behavioural constraint on government action.
The mainstream literature emerged in the 1960s during a period when the neo-classical microeconomists were trying to gain control of the macroeconomic policy agenda by undermining the theoretical validity of the, then, dominant Keynesian macroeconomics.
They claimed that just as an individual or a household is conceived in orthodox microeconomic theory to maximise utility (real income) subject to their fiscal constraints, this emerging approach also constructed the government as being constrained by a fiscal or "financing" constraint.
So within this model, taxes are conceived as providing the funds to the government to allow it to spend.
Further, this approach asserts that any excess in government spending over taxation receipts then has to be "financed" in two ways: (a) by borrowing from the public; and (b) by printing money.
In a fiat currency system, the mainstream analogy between the household and the government is flawed at the most elemental level.
The household must work out the financing before it can spend. The household cannot spend first. The government can spend first and ultimately does not have to worry about financing such expenditure.
From a policy perspective, the mainstream rests on a series of interlinked myths:
1. Via the Quantity Theory of Money, if central banks 'print money' inflation follows.
2. Fiscal deficits should therefore be 'funded' by debt-issuance, which then ncrease interest rates by increasing demand for scarce savings and crowd out private investment. The negative impact on private investment is referred to as 'crowding out'.
3. Central bank money creation is erroneously depicted as the government asking the central bank to buy treasury bonds which the central bank in return then prints money. The government then spends this money. This is called debt monetisation and these blog posts - Deficits 101 series - show how this conception is incorrect.
4. Ultimately taxes have to rise in the mainstream conception because debt has to be 'paid back'.
None of the above have any applicability to the real world.
To understand the answer we have to convert the above expression into one that describes the change in the public debt ratio:
The change in the debt ratio is the sum of two terms on the right-hand side: (a) the difference between the real interest rate (r) and the GDP growth rate (g) times the initial debt ratio; and (b) the ratio of the primary deficit (G-T) to GDP.
A growing economy can absorb more debt and keep the debt ratio constant.
For example, if the primary deficit is zero, debt increases at a rate r but the debt ratio increases at r - g.
So a change in the change in the debt ratio is the sum of two terms on the right-hand side: (a) the difference between the real interest rate (r) and the GDP growth rate (g) times the initial debt ratio; and (b) the ratio of the primary deficit (G-T) to GDP.
Consider the following table which simulates two different scenarios. Case A shows a real interest rate of zero and a steadily increasing annual GDP growth rate across 10 years.
The initial public debt ratio is 100 per cent.
The fiscal deficit is also simulated to be 5 per cent of GDP then reduces as the GDP growth induce the automatic stabilisers. It then reaches a steady 2 per cent per annum which might be sufficient to support the saving intentions of the non-government sector while still promoting steady economic growth.
Even with a continuous fiscal deficit, the public debt ratio declines steadily and would continue to do so as the growth continued.
The central bank could of-course cut the nominal interest rate to speed the contraction in the debt ratio although I would not undertake that policy change for that reason.
In Case B we assume that the government stops issuing debt with everything else the same. The public debt ratio drops very quickly under this scenario.
However, should the real interest rate exceed the economic growth rate, then unless the primary fiscal balance offsets the rising interest payments as percent of GDP, then the public debt ratio will rise.
The only concern I would have in this situation does not relate to the rising ratio.
Focusing on the cause should be the policy concern.
If the real economy is faltering because interest rates are too high or more likely because the primary fiscal deficit is too low then the rising public debt ratio is just telling us that the central bank should drop interest rates or the treasury should increase the discretionary component of the fiscal balance.
In general though, the public debt ratio is a relatively uninteresting macroeconomic figure and should be disregarded.
If the government is intent on promoting growth, then the primary deficit ratio and the public debt ratio will take care of themselves.
You may be interested in reading these blog posts which have further information on this topic: