Is Debt Good or Bad? Answer: It depends.

• Author: Sobel, Mark

With sovereign debt continuing its seemingly inexorable rise, debates rage across the globe-are government debt and deficits good, bad, or ugly? Like so much in economics, the answer is "it depends." Of course, a country should fund its spending needs, in particular to defend its people and protect their wellbeing. But is it smart to take on debt to do so? The Good: Countries with fiscal space wisely added to debt to offset shortfalls in private demand during the global financial crisis and the Covid pandemic. While the case to take on debt in a crisis is clear, there can also be good arguments for doing so when an economy faces output gaps.

But the flip side is that deficits should be restrained when a country is operating above potential. Debt can also be growth-enhancing by funding infrastructure, climate, and other public goods, and helping catalyze private sector investments with high rates of return that might not otherwise be undertaken. Financing investments, particularly amid negative real rates, makes sense.

The Bad: There can be too much of a good thing. Fiscal policy doesn't lend itself readily to fine-tuning. Politicians often seek to fund consumption, rather than long-term growth-enhancing investments. They do so without regard to macroeconomic stabilization concerns or the economic cycle. Higher debt service costs can squeeze fiscal space needed to finance governmental priorities. Running up debts allows the political class to avoid taking responsibility for tradeoffs between restraining spending and raising revenue. The consequences for inflation, growth, and employment can be adverse.

The Ugly: Sometimes debt buildups cause fiscal dominance, forcing central banks to monetize debt, which can ratchet up inflation, cause currency crashes, and eviscerate financial systems.

Adding to the complexities of assessing the good, bad, and ugly: * Debt sustainability, like fiscal space, is difficult to quantify or define. It depends on unknowns, such as market sentiment and a country's future economic performance. Can a country run sound policies and implement reforms? How much debt does it already have? What is the maturity profile and rollover risk? Is debt denominated in local or foreign currency? Can the country tap into a large domestic saving pool?

* Economists often look at the debt-to-GDP ratio as a proxy for assessing debt sustainability. It is a highly imperfect measure. Particularly in a world of low real interest rates, debt...