International economists are warning about rising global debt levels and deficit hawks in Washington are increasingly worried about what they see as unsustainable debt levels in the U.S., but a new economics paper raises some interesting questions about the debt carrying capacity of advanced economies.
Philip Barrett, an economist at the International Monetary Fund, notes that debt has been rising throughout much of the developed world over the last 35 years, but interest rates have been steadily falling. Does that mean that higher levels of debt are now safe and sustainable?
Barrett’s answer to the question revolves around the relationship between interest rates and growth rates. Importantly, Barrett argues that growth rates have generally exceeded interest rates over the long run in the handful of advanced nations he examines, dating back to the 19th century. Under those conditions, a country can afford to service its debt indefinitely. And, in perhaps the most startling conclusion, the size of the debt is largely irrelevant. All that matters are the debt service costs and the rate of economic growth.
That’s not to say, however, that wealthy nations – the paper examined data from only the U.S., U.K., France and Germany – face no constraints when it comes to issuing national debt. Debt problems emerge when growth rates fall below interest rates, though Barrett thinks there’s probably some wiggle room of a few percentage points in the differential. The structure of the debt matters a lot, too, since most countries roll over their debt rather than paying it off, and there is always the risk of getting caught refinancing during a period of high interest rates. And maintaining access to the debt markets is crucial.
But perhaps the most interesting idea suggested by the analysis is that there is no fixed point at which debt becomes unsustainable – no absolute limit in terms of dollars or ratios that signals a deadly turning point, at least not for wealthy counties with long, stable track records like the U.S. and Germany. At the same time, though, as we know from history, that turning point almost certainly exists, even if we can’t measure it precisely. For that reason, Barrett recommends caution when it comes to expanding national debt.