Let me offer you an enticing proposition. It consists of borrowing money at 2% to invest in something growing at 4%. That’s a good deal, wouldn’t you agree?
Most of us would say yes if we were discussing our RRSP.
Yet here's the funny thing: When faced with the same math on the national budget, Ottawa rejects it. In fact, politicians pride themselves on doing so and voters, by and large, agree. They hate the idea of the government paying interest on debt at 2% a year (the current yield on a 10-year Government of Canada bond) to invest in something growing at 4% (a reasonable estimate of the long-term growth outlook for the Canadian economy, factoring in both inflation and real expansion).
Why should we turn down a deal on the national level that we would jump to embrace in our personal lives? It's a question that will be central to politics over the next few years, especially if the global economy hits another soft patch. And it's a question that deserves a better answer than the usual patter about the virtues of balanced budgets.
It deserves a better answer because fiscal restraint and low interest rates—the establishment's favoured remedies for treating ailing economies—have failed to deliver widespread prosperity in the wake of the 2008-09 financial crisis. In Europe, a decade of austerity has gone hand in hand with high unemployment and a weak, faltering recovery. In the United States, Washington's reluctance to spend more aggressively in the years after the crisis held back growth and embittered voters, especially in the hard-hit Rust Belt.
Maybe slow growth is simply a fact of life now. But the tensions it is creating, demonstrated by the rise in populism in Europe and North America, have left a lot of people wondering if we can't find a more reliable way to deliver prosperity and avoid long, lingering downturns.
Many left-wingers have fallen in love with Modern Monetary Theory (MMT), a muscular restatement of Keynesianism that argues, among other things, that governments should spend whatever it takes to restore full employment following a downturn. Over the past few years, MMT has moved from the fringes of economic discussions to something approaching respectability. Critics are happy to point out exceptions to its logic or argue it's not really anything new, but MMT no longer gets dismissed out of hand.
Even mainstream economists are now rethinking debt. One sign of the changed attitude came in January, when Olivier Blanchard, one of the world’s leading macroeconomists, delivered his presidential address to the American Economic Association. He began his presentation by highlighting one simple but surprising fact: In every decade since the 1950s, except the 1980s, the interest rates on government debt in advanced countries have been lower than the growth rates of their underlying economies. (To be clear, we’re talking about the nominal growth rate—in other words, real growth plus inflation. The growth figures you see reported in the media are typically only the real growth rate, with inflation excluded.)
The persistent ability of governments to borrow money at rates below that of economic growth suggests much of the scary math routinely touted by debt and deficit scolds does not stand up. If a government can borrow money at 2%, and the economy is growing at 4%, then the ratio of a country's debt to GDP shrinks over time, even if politicians don't raise taxes.
“What [this] means is that one of the standard objections to raising debt, which is that taxes will have to rise to pay the interest, no longer holds true,” says Simon Wren-Lewis, an emeritus professor of economics at the University of Oxford who is trying to combat debt phobias. “Indeed, the whole 'burden on future generations' objection to raising debt falls away, because the debt-to-GDP ratio declines by itself: There is no future burden.”
Now let’s not get carried away: This is no licence for governments to spend willy-nilly on everything their supporters might like. As Wren-Lewis points out, a government that permanently spends more than it takes in can still run into trouble if those persistent deficits put the debt-to-GDP ratio on a permanent rising track. Policy-makers still have to keep a close eye on spending during good times.
But in bad times? Or if there is a crying need for new public infrastructure?
Then a large burst of public spending can be not only useful, but also relatively painless to support in years to come. As Blanchard says, it's not that debt itself is necessarily good, but it's not as bad as we've been told. This is something that politicians in Europe might want to ponder. And it is something that politicians in Canada should keep in mind the next time our economy stutters.