This is generally agreed to have been a good thing. The United States for example borrowed funds (and compelled its citizens to lend it funds) to fight the Nazi's. This can be a bad thing, but this can also be a good thing. The government usually borrows funds to spend it and re-allocate scarce resources. Now you've mentioned some consequences of public debt. The same quantity of alcohol is just right in one situation and too much in another situation because of the consequences. This is generally considered a bad thing. Drink five or six glasses of beer in the afternoon at the office and you can get fired. But how much alcohol is too much? When you're with a group of friends and you all drink five or six glasses of beer, and do stupid things together then you're probably having a good time.
Too much alcohol can make you do stupid things which you'll later regret. But how do you know that these are too much? These are all bad things because they are too much. The debt to GDP ratio becomes a bad thing when it is too high. A high debt to GDP ratio cannot be bad by itself. Let me dispute the premise of the question. Therefore, we only expect money to grow in line with transaction needs, and this level may have little resemblance to total debt levels. In most modelling traditions, people only target a certain anount of money holdings (that earn no interest), and the rest is invested in bonds/bills. In any event, the central bank needs to pay interest on resserves if it wishes to raise market interest rates to control inflation, and the consolidated government will face a similar interest cost as the case of bill issuance.įinally, the money supply is related to debt levels both are forms of government liabilities. In the case where the central bank has bought a lot of government debt (quantitative easing), the expectation is that the central bank will eventually reverse that policy. (I have severe doubts about the mathematics behind it, for what that's worth.) (This is sometimes called Ricardian Equivalence.) The exact mechanism is controversial. This view can be summarised as: greater debt now means greater future taxes, and people do not like taxes. There is a school of thought that argues that we need to "pay back" debt in some sense this is often referred to as the governmental budget constraint. The example of Japan in recent decades (high debt ratios, low nominal yields) demonstrates that the effect is not very large, even if it exists. The magnitude of this effect is controversial.
There are two ways in which a greater debt load increases interest payments. The exact mechanisms are debated by various schools of thought, but it is reasonably safe to argue that greater interest payments will squeeze out other spending if we want to keep inflation around a target level. However, even if we ignore default risk, the greater the debt level, the greater the interest expense for the government. If the country controls the currency it borrows in, it should be able to arrange its affairs to avoid default. You need to look at other things as well, but it's one common metric.
There is no gurantee that they can their hands on the foreign currency to repay debt.
(One can argue that GDP represents the full income capacity of the economy for debt service.)įor countries that borrow in a foreign currency (or in a currency where they do not directly control the central bank), a high debt ratio indicates a greater risk of default. However, the convention to use GDP for scaling these series. One could easily look at debt/government revenue, and it may be a more useful metric. Firstly, the use of debt/GDP as the ratio is somewhat arbitrary.