In a 1937 radio address, the economist John Maynard Keynes said that “the boom, not the slump, is the right time for austerity at the Treasury.” The time to pay down debt isn’t when the economy is weak, since the necessary spending cuts and tax increases would exacerbate a recession, but instead when times are good.
But what if good times aren’t right for austerity either? What if we should just service our debt—i.e., pay the minimum—and chill? This piece of advice is coming from an institution that, for many on the left, is synonymous with austerity: the International Monetary Fund. The IMF’s retiring research chief, Olivier Blanchard, is an MIT-trained New Keynesian, and the research team he oversaw during the Great Recession pushed the discussion into brand-new territory. A recent paper by IMF economists Jonathan Ostry, Atish Ghosh, and Raphael Espinoza is titled “When Should Public Debt Be Reduced?”, and their surprising answer is, for a country like the United States, not in the near future.
As background, the national debt did increase as a result of the Great Recession. As the economy weakened, the government took in less in taxes and paid out more in support. These “automatic stabilizers” put a floor under demand and helped keep the Great Recession from turning into the next Great Depression.
The government deficit increased throughout the worst of the recession, before falling and leveling off at a low rate. Now the deficit is just 2.4 percent of the GDP—lower than the average over the past 50 years. But the total amount of government debt has plateaued at a higher level. In 2007, the ratio of debt held by the public to GDP was about 35 percent; now it’s 74 percent.
To understand the IMF’s analysis, we must remember that the debt is what economists call a “sunk cost,” since the money has already been spent. We are left to consider the benefits and costs of this spending decision: Would our economy benefit most from throwing money at the debt, or investing it in something else?
There can be benefits to lower debt, but they don’t provide much value for the United States right now. A lower debt level can give us breathing room for the next recession, when we’ll need to borrow again. But the United States, with low interest rates and the ability to issue significantly more debt, already has sizable room.
Plus the costs of paying down the debt are real. Taxes would have to be raised, or spending cut, in order to do so, and the costs to society of those taxes and cuts are easily greater than whatever negligible breathing room they would gain us. Worse, in a period of secular stagnation, with low interest rates, weak demand, and consistent crises coming out of China and Europe, trying to lower the deficit might just be counterproductive, triggering the very recession it was meant to prevent.
American debt can even be an important asset. There’s been what finance experts call a “safe-asset shortage,” or a lack of dependable debt that can be used for collateral in other economic transactions. Only the government can provide debt that is safe from the business cycle. Before the financial crisis, Wall Street bankers tried to financially engineer their own safe assets by bundling subprime mortgages, which failed disastrously. There are already worries that US debt will be too low, not too high, to provide enough safe collateral in the next financial crisis.
Finally, we must remember that countries aren’t households: They don’t reduce their debts by spending them down, but rather by holding them steady and growing out of them. For a country like the United States, the debt is something we ultimately owe to ourselves. Since we print the money we use, it simply sets the course of our macroeconomic direction. Investment in things that increase our growth, from infrastructure to education, is a better use of spending than reducing the debt.
Chilling and letting the debt shrink is what we did in the aftermath of the Great Depression and World War II. Back then, we ran a deficit, but the debt declined significantly because of higher growth and inflation. It is also, if the right course is followed, what we’ll do after the Great Recession.