Ken Rogoff:
Austerity and Debt Realism: Many, if not all, of the world’s most pressing macroeconomic problems relate to the massive overhang of all forms of debt…. [W]hat should governments be doing? One extreme is the simplistic Keynesian remedy that assumes that government deficits don’t matter when the economy is in deep recession; indeed, the bigger the better. At the opposite extreme are the debt-ceiling absolutists who want governments to start balancing their budgets tomorrow (if not yesterday). Both are dangerously facile.
The debt-ceiling absolutists grossly underestimate the massive adjustment costs of a self-imposed “sudden stop” in debt finance….
If the debt-ceiling absolutists are naïve, so, too, are simplistic Keynesians. They see lingering post-financial-crisis unemployment as a compelling justification for much more aggressive fiscal expansion, even in countries already running massive deficits….[I]t is wrong to think that massive accumulation of debt is a free lunch…. [V]ery high debt levels of 90% of GDP are a long-term secular drag on economic growth that often lasts for two decades or more. The cumulative costs can be stunning. The average high-debt episodes since 1800 last 23 years and are associated with a growth rate more than one percentage point below the rate typical for periods of lower debt levels…. [Y]es, government spending provides a short-term boost, but there is a trade-off with long-run secular decline.
It is sobering to note that almost half of high-debt episodes since 1800 are associated with low or normal real (inflation-adjusted) interest rates. Japan’s slow growth and low interest rates over the past two decades are emblematic.
Moreover, carrying a huge debt burden runs the risk that global interest rates will rise in the future, even absent a Greek-style meltdown. This is particularly the case today, when, after sustained massive “quantitative easing” by major central banks, many governments have exceptionally short maturity structures for their debt. Thus, they run the risk that a spike in interest rates would feed back relatively quickly into higher borrowing costs….
I will also return to the theme of why this is a time when elevated inflation is not so naïve. Above all, voters and politicians must beware of seductively simple approaches to today’s debt problems.
