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How much debt is too much?

Raghuram G. Rajan
Raghuram G. Rajan12/11/2020 07:00 AM GMT+08  • 6 min read
How much debt is too much?
How much debt can a government issue to protect the economic capacity of households and firms during Covid-19?
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As the Covid-19 pandemic rages, governments in advanced economies have opened their coffers to support households and small businesses, spending on the order of 15–20% of GDP in many cases. Cumulative debt levels now exceed GDP in many developed countries; and, on average, debt as a share of GDP is approaching post-World War II highs.

Nonetheless, according to Olivier Blanchard and other economists, advanced economies can afford to take on much more debt, given the low level of interest rates. Calculations using International Monetary Fund data show that in the two decades before the pandemic, sovereign interest payments in these countries fell from over 3% of GDP to about 2%, even though debt-to-GDP ratios increased by more than 20 percentage points. Moreover, with much of the newly issued sovereign debt now paying negative interest rates, additional borrowing stands to reduce interest expenses even more.

In this strange world of ultra-low interest rates, what limits are there on government borrowing? According to advocates of Modern Monetary Theory (MMT), there are none, at least not for countries that issue debt in their own currency and have spare productive capacity. After all, the central bank can simply print money to pay off maturing debt, and this should not result in inflation as long as there is sizeable unemployment. No wonder MMT has become the go-to idea for politicians advocating government spending to alleviate every problem.

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