Does the national debt matter?

Abstract

In this paper, we use the Modern Money Theory framework to analyze whether government debt (and deficits) in a country with its own sovereign currency presents a problem. We argue that permanent deficits and even a rising debt ratio are normal, especially in developed nations with current account deficits. In contrast to the conventional approach, which views deficits and debt as policy variables, we demonstrate that they are ex post outcomes which depend on economic performance. Further, in nations with sovereign currency, it is hard to imagine a scenario in which a rising deficit and the debt ratio would trigger an attack by bond vigilantes, lead to government insolvency, or generate high inflation or high interest rates. The claim that debt beyond a certain threshold impairs growth is also suspect since the observed empirical correlations are likely due to lower growth creating higher deficits. Lastly, we argue that deficit and debt ratios have no bearing on a nation’s fiscal policy space, which depends on the real resources it can mobilize.

Notes

1 See, for example, Rezende (2009); Jorge (2020); Wray and Liu (2014); and Mitchell (2016b).

2 See Kaboub (2019), Samba Sylla (2020), as well as this panel at the 3rd MMT Conference (2019), available at: https://www.youtube.com/watch?time_continue=518&v=lSCpJ3dSJ24.).

3 See Goodhart (1998). Note that the main purpose of his paper was to argue that the newly emerging euro area was an unprecedented deviation from the norm and that it likely would not turn out well. MMT (as well as Wynne Godley at the Levy Institute) reached a similar conclusion and in all important respects accurately predicted what would go wrong.

4 See, for example, the view in Japan in Nikkei Staff Writers (2019). In the US, Kenneth Rogoff (2019) labeled MMT “nonsense”; Larry Fink, CEO of BlackRock, called it “garbage” (Collins 2019); Paul Krugman (2019) said its claims were “obviously untrue”; and Larry Summers (2019) called it “voodoo economics”. For links and a considered response to each of these attacks, see Montier (2019). For responses to critics see Wray (2019a, 2019b, 2019c, 2019d, 2019e, 2019h, 2019i) and Mitchell (2019a, 2019b).

5 See Innes (1913, 1914), Grubb (2015), Hudson (2004), Graeber (2011), Ingham (2000), (Keynes 1976 [1930]), and Wray (1990, 1998, 2015) for discussions of the history of money that are consistent with the MMT view.

6 Case in point, before the creation of the Fed, whenever the U.S. government ran surpluses, it created a shortage of currency. It then tried to ameliorate this shortage by buying back its bonds as a way to inject currency withdrawn from circulation (due to the surplus) back into circulation (Chapman 1923).

7 The U.S. did not start using an auction system for longer-term treasury bond sales until 1970 (short-term securities were sold on an auction basis since 1950s). Prior to that, Treasury securities were offered on a fixed-price basis (Garbade 2012).

8 Total government spending is the sum of spending by the federal and state and local governments.

9 Note that while state and local government spending is large (approximately two-thirds the size of the federal government), the movement of the overall balance is mainly due to adjustments of the federal government balance (state and local government spending is largely constrained to tax revenues).

10 Obviously, a net exporter like Japan is in a different position, with its private sector surplus equal to the sum of its government budget deficit plus the ROW’s negative balance against Japan. This is why Japan’s private sector can accumulate net savings.

11 Source: Congressional Budget Office Historical Tables.

12 The authors thank Eric Tymoigne for supplying Figures 9 and 10.

13 Figure 10 does not include all private commitments as the more exotic financial liabilities—derivatives, swaps, etc.—are excluded, so total private obligations are much higher than this.