The bad news first: there is no magical number of a debt to GDP ratio as an answer to the question of how much debt is too much. On this, all panelists were in agreement. The good news: there were enough interesting topics to discuss in the new episode of the Debt Talks Series hosted by the Institute for New Economic Thinking. Panelists were Claudia Sahm, founder of Stay-At-Home-Macro and former Federal Reserve economist, Ludwig Straub, Assistant Professor at Harvard University, Rüdiger Bachmann, Professor at University of Notre Dame, and the session was moderated by Moritz Schularick, Professor at University of Bonn and in the Research Department of the Federal Reserve Bank of New York.
The dawn of a new era?
We have written earlier about how Bidenomics with massive fiscal expansion may induce a new paradigm in macro policy. Whether the shift from monetary to fiscal dominance in macro stabilization policy is the dawn of a new era, was also one of the hot topics in this session. According to Claudia Sahm, macro policy has undergone a sea change in the last decade. Capital markets during this time are best described by the term saving glut. The underlying causes for excess savings over investments include structural reasons like ageing populations, saving for retirement. Another explanation, Ludwig Straub pointed out, focusses on the rise of inequality, given that rich people save more. Excess saving pushes interest rates down and entails sluggish growth. Hence, the conventional monetary policy tools are constrained, the hands of central bankers tied. In order to stimulate the economy, they now have to implement unconventional monetary policies, leading to what Ludwig Straub has called secular stagnation on steroids. As Claudia Sahm noted, nonstandard actions of central banks go with problems regarding inequality, wich could further aggravate the saving glut. Thus, it seems like it is time for fiscal policy to step in. The question is: how?
What should be done with the money?
When talking about how much debt (to GDP) is too much, there is always a second side of the coin: how much GDP (growth) is too little? Claudia Sahm demanded that we need the growth rate big. What should fiscal policy look like to achieve this goal? According to Ludwig Straub, fiscal policy can step in and close the gap between savers and spenders by raising public expenditure. Furthermore, it can also address the underlying reasons like inequality with more redistribution, or public investments in schools. Governments should take advantage of excess saving of the private sector, and borrow at low interest rates to finance their activities.
Austerity for future fiscal space? The German debt brake perspective
Does this mean that public debt has no constrains at all? With the introduction of the debt brake, Germany seems to have found its answer to the question of how much debt is too much. According to Rüdiger Bachmann, the fiscal rule in its current state is economically stupid, as it is not sufficiently state dependent. However, generally he is in favour of a rule of some sort to deal with time inconsistency problems arising from governments that want to be reelected. Since it is difficult to write a market based rule in the constitution, he has suggested to introduce an independent fiscal council as an extension of the debt brake . Regarding the US case, Bachmann already observes some negative supply side effects of the big Biden packages, like labour shortages. All panelists agreed, that there are always trade offs and also public indebtedness has its limits, but one should not solemnly focus the costs of public debt without considering the costs of underinvestment, low growth and unemployment.
The whole session will soon be published here .
A previous session of the Debt Talks Series on European banks was hosted by the Forum and the Institute for New Economic Thinking together.