Has the world been fitted with a debt straightjacket?

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The world's combined public and private debt is approaching 300 percent of GDP. In the United States, public debt alone under Presidents George W. Bush and Barack Obama jumped from $5.8 trillion in 2001 to $20 trillion in 2016, a 250 percent increase. According to the U.S. Congressional Budget Office, interest payments on that debt increased by almost $30 billion for just the first six months of FY 2017--a nearly 23 percent jump. As the Federal Reserve and other central banks return interest rate policy to its historic norm, will the increased spending necessary to finance today's massive debt impede economic growth? Or can the global economy handle today's debt load? Some analysts suggest that in recent decades, Japan with its massive debt theoretically couldn't achieve higher levels of economic performance precisely because higher interest rates would have risked a bank balance sheet crisis. How problematic is today's debt?

Nearly forty distinguished experts offer their wisdom.

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Yes, the straightjacket is caused in large part by excessive leverage.

JEAN-CLAUDE TRICHET

European Chairman, Trilateral Commission, former President, European Central Bank, and Honorary Governor, Banque de France

Indeed we are presently fitted with a debt straightjacket! The global financial crisis starting in 2007-2008 had many causes. But one of the most important was the excessive financial leverage characterizing particularly the advanced economies.

Due mainly to these economies, the piling up of additional global public and private debt outstanding in the years preceding the eruption of the crisis had been very impressive. According to the report "Shadow Banking and Capital Markets," published last year by the Group of Thirty, the overall global debt outstanding as a proportion of global GDP increased from 250 percent to around 275 percent, from 2000 to 2007. Adding around one-quarter of global GDP to global debt outstanding during the seven years preceding the crisis was a major mistake by the international community.

Taking into account, first, the extreme acuteness of the financial crisis, second, the fact that the international community avoided a dramatic depression only because central banks, in particular, were extraordinarily swift and bold in their decisions, and, third, the gravity of the recession accompanying the financial crisis, one would have expected some stabilization of the global debt outstanding as a proportion of global GDP. That is not the case.

Global financial leverage continued to increase at the same pace. According to the same Group of Thirty report, eight years after the start of the crisis, a new quarter of global GDP was added to global debt outstanding, pushing up the global leverage at the level of more than 300 percent in 2016 (other methodologies would suggest slightly different figures but would lead to the same conclusion as regards the continuing pace of additional leverage).

This global phenomenon is very worrying. It is obvious that the global economy is today more vulnerable, seen through this systemic financial indicator, than it was at the eve of the crisis. And the fact that the increase of leverage was more moderate after the crisis in the advanced economies which were at the epicenter of the crisis and much more dynamic in the emerging economies which, for most of them, were not directly touched by the financial crisis, is not reassuring in my eyes.

More than ever, for all decision makers--global, continental and national--systemic vigilance is of the essence. On top of sound monetary policies solidly anchoring inflation expectations and attentive monitoring of the micro and macroprudentials which are of the essence, I would stress the three following recommendations which would foster medium- and long-term growth and job creation, and contribute to reduce systemic financial vulnerability:

First, in most economies, investment should be favored instead of consumption, in order to pave the way for higher long-term potential growth. This is particularly true in advanced economies.

Second, more "expansive" fiscal policies, often suggested, should be understood as favoring medium- and long-term growth through optimization of public spending and taxation but not through augmentation of deficits in countries already in deficit. This would do nothing but add further to their vulnerability and global public finance leverage. The call for more deficits should be limited to the handful of economies that are posting surpluses, with the understanding that others are reducing their deficits... Otherwise what will we do when the economic cycle is less favorable?

Finally, in the private sector, everything should be done to boost equity instead of debt financing. Many countries and economies are still favoring debt instead of equity, in particular through taxation. This is not only an economic mistake but also a dangerous policy, which increases systemic financial risks at national and global levels.

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C. EUGENE STEUERLE

Richard B. Fisher Chair and Institute Fellow, Urban Institute

A straightjacket, yes, but debt defines its features poorly. Debt is merely one symptom of a disease that has vastly restricted the ability of developed nations to respond to new needs, emergencies, opportunities, and voter interests. The disease: the extraordinary degree to which past policymakers have attempted to control the future--building automatic growth or growing public expectations into existing spending and tax subsidy programs while refusing to collect the corresponding revenues required to pay for them.

In my 2014 book Dead Men Ruling, I show how this leads to a "decline in fiscal democracy"--the sense by officials and voters alike that they have lost control over their fiscal destiny. Though the degree and nature of the problem varies by type of government and culture, research so far in the United States and Germany, two countries with greater fiscal space than most other developed countries, confirms this historic shift.

We must understand how we got here if we ever expect to get a cure, since defining the problem by the debt symptom has led mainly to periodic deficit cutting that leaves the same long-term bind, frustrating voters and officials alike while increasing the appeal of anarchists and populists.

For most of history, nations with even modest economic growth wore no long-term fiscal straightjacket. Even with the debt levels left at the end of World War II, economic growth led to rising revenues, while most spending grew only through newly legislated programs or features added to programs. Typically existing programs were expected to decline in cost, for example, as a defense need was met or construction was completed.

Until recent decades, budget offices did no long-term projection, but if they had, they would have revealed massive future surpluses over time even when a current year revealed an excessive deficit. Year-after-year profligacy was still a danger, but it wasn't built into what in the United States is referred to as "current law."

Today, rising spending expectations are built into the law through features such as retirement benefits that rise with wages, expectations that health care spending will automatically pay for new innovations, and failure to adjust for declining birth rates and the corresponding hit on spending, employment, and revenues. At the same time, officials fail to raise the revenues required to meet, much less fund, those laws or voter expectations.

A rising debt level relative to GDP is merely one symptom. Reduced ability to respond to the next recession or emergency is another, while the increasing share of government spending on consumption and interest crimps programs oriented toward work, investment, saving, human capital formation, and mobility.

Politically, the chief budget job of elected officials turns from give-aways to avoid growing surpluses to take-aways that renege on what the public believes is promised to them. Economic populists, fiscal hawks and doves alike, don't help when their fights over short-run austerity ignore the fundamental long-term disease.

The bottom line: flexibility, not merely sustainable debt, is required for any institution--business, household, or government--to thrive.

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THOMAS MAYER

Founding Director, Flossbach von Storch Research Institute, and former Chief Economist, Deutsche Bank

It seems that Japan's experience of the last three decades has been replicated on a global scale. During the 1980s, the Bank of Japan felt that a relatively loose monetary policy was appropriate as consumer price inflation was well-behaved. The Bank neglected the surge in asset prices until it was too late. When the asset price bubble burst, fiscal and monetary policy came to the rescue. A serious recession was averted, but at the same time structural adjustment was impeded. Thanks to low interest rates, a very high level of debt became sustainable. But the debt overhang stifled economic growth. A fragile equilibrium emerged, where low growth led to low inflation, which made the debt overhang sustainable, which in turn depressed economic growth.

With about twenty years delay, the United States and Europe have followed in Japan's footsteps, by first allowing a real estate bubble to emerge and then countering the recessionary effects from the ensuing financial crisis with low interest rates. Like in Japan, structural adjustment has been impeded and a debt overhang has become entrenched.

As long as there is no exogenous shock to inflation, the fragile equilibrium will continue. Inflation has been very low on trend in Japan since the early 1990s and it has been low in other industrial countries since the financial crisis of 2007. But the fragile equilibrium will break apart when inflation eventually rises. Then, central banks will be confronted with the choice of either raising...

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