বৃহস্পতিবার, ১৫ নভেম্বর, ২০১২

Where is the line between good debt and bad debt? ? David Akin's ...

A wonk-post, I?m afraid, but there are some important questions, I think, for politicians and voters at the end of it all.

In 2000-2001, the debt-to-GDP ratio was 48.3 per cent. By the time of the final Liberal budget, the one for the fiscal year that ended on March 31, 2006, the debt-to-GDP ratio was at 35%. (All the ratios and figures in this post come from the federal Finance Department?s Fiscal Reference Tables)

The debt-to-GDP fell for one of these reasons:

  1. The absolute amount of debt issued by the Government of Canada falls while total economic output (GDP) stays the same.
  2. The absolute amount of debt issued by the Government of Canada stays the same while GDP rises.
  3. The absolute amount of debt changes at a slower rate than the rate of growth of our economy.

Usually, the debt-to-GDP ratio drops because of that last point. If our economy is growing at, say 2 per cent a year, our debt-to-GDP ratio drops if debt ?grows? at, say -5% a year. That is to say, the economy was growing while debt decreased in absolute terms. Our debt-to-GDP ratio could drop if the economy grows at 3 per cent and debt grows at 1 per cent. In both these cases, the economy has grown but debt has grown at a slower pace than the economy.

Some (and perhaps many or even a majority of) economists ? and I wish I could finger the ones who told me this but it?s been a long time since I?ve brought this up ? argue that it is a desirable policy outcome that governments carry some sort of debt as government debt because low-risk government debt is part of a healthy and functioning capital market and healthy capital markets are important in order to finance economic development projects which in turn create jobs and prosperity. Not only that, Canada Savings Bonds are clearly among the most popular of investment products Canadians choose every year. When the government issues you a $100 Canada Savings Bond, that?s $100 in debt that we are all taking on through our federal government.

So, I would argue there is widespread agreement that it is an undesirable policy goal for a federal government in Canada to completely wipe the federal debt out, i.e to bring the debt-to-GDP ratio down to zero.

But on the other hand, when our federal debt-to-GDP ratio was peaking in the mid 1990s at around 68%, there seemed to be widespread agreement that the government had taken on too much debt and that this was an undesirable policy outcome. For one thing, just the interest on that debt was equivalent to 6.1% of GDP in 1995-1996.

So what is the optimal federal debt-to-GDP ratio? Where is the line between good debt and bad debt? Clearly, it?s somewhere between 0% and 68%

This is not just an academic question but one with very important consequences for politics and federal fiscal policy.

In the 2008-2009, the debt-to-GDP ratio was 28.9 per cent, the lowest it had been since 1979-80 when it was 27.7%. ?After that, and for the last three years, it has hovered around 34% as the federal government ran up deficits to pay for what it deemed were important stimulus programs needed as a counter to the global recession.

In the fall fiscal and economic update released this week by Finance Minister Jim Flaherty, there seemed to be a clear objective that the federal government ought to return to a debt-to-GDP ratio of around 28 per cent, as if that was some sort of optimal level. Here?s this line from Flaherty?s speech?announcing the update:

?Through our Government?s continuing efforts to eliminate the deficit, the federal debt, measured in relation to the size of the economy, is projected to fall to 28.1 per cent in 2017?18, in line with the recent low in 2008?09. This will help ensure that Canada?s total net debt-to-GDP ratio will remain the lowest among all other G-7 countries by far.?

But, so far as I can tell, neither Minister Flaherty nor any finance department official has provided an explanation of why 28% is an optimal level. Why not 25%? What?s wrong with the current 34%? All we get from Flaherty is that having a net debt-to-GDP ratio that is lower than our G7 peers appears to be a good thing. Why? (Germany?s debt-to-GDP ratio is second best to Canada right now and their ratio is closer to 60% right now and most thing Germany?s economy is doing pretty well all things considered. Do we know something the Germans don?t?)

For example, I might, as a policy outcome, favour lower taxes. But (and I know I?m probably oversimplifying things here) a government might say that it needs to keep my taxes where they are so that it can pay down debt ? and reduce the debt-to-GDP ratio possibly. This then is the key political question: Lower taxes or lower the debt? But I might argue that the debt-to-GDP ratio is fine where it is and that our economy would grow faster if you cut my taxes. And, of course, if you cut my taxes and the economy did in fact grow, than you would be lowering the debt-to-GDP ratio! (see Reason Number Two at the top of this post).

But here?s another political question: The choice is not between cutting debt and cutting taxes but cutting debt or spending that money on some other public good such as more infrastructure, helping unemployed people get jobs,etc. That, it seems to me, is one of the fundamental questions over which Conservatives, Liberals and New Democrats tend to divide themselves. All parties agree with some debt reduction; all agree with some program spending; all would favour some reduced taxes. Where they differ is getting the balance among all three of those things.

I think it safe to say that all three parties have sketched out justifications for their favourite program spending priorities and for their priorities on taxation. But while all parties think lower debt is a good thing, I am not aware of any of them spelling out just how low they want to go with this debt reduction thing or what their rationale is for debt reduction targets or rates or debt reduction.

One final note related to all of this:

Some say, well, you?ve still got to pay interest on that debt and if the government didn?t have to pay that interest (i.e if there was less absolute debt), it could spend that money on other things or reduce taxes. In the last budget year, the federal government had to pay more than $31 billion in public debt charges or interest.

That seems a lot of money but the important assumption for this discussion is that some debt and therefore some interest payment is a desirable policy outcome. And, though the current Conservative government has run up what are, in absolute terms, Canada?s largest ever budgetary deficits, the ratio of interest-to-GDP has been below 2% for the last three years. (Remember it was 6.1% during the federal government?s last big deficit crisis of the early- to mid-1990s). In fact, that $31 billion in interest paid by the feds last year was the equivalent of 1.8% of GDP. ?The interest-to-GDP ratio has not been 1.8% since 1966! In other words, this is pretty much an all-time low for interest charges in relative terms.

Even more remarkably, it seems to me, is that there was $842 billion in interest-bearing debt on the government?s books last year. So Canadian taxpayers were paying about 3.6% to borrow that money. If I was paying 3.6% on my mortgage, I think I?d be pretty happy. Others might be upset at paying any amount of interest. Fair enough.

So maybe here?s another benchmark to guide our policy decisions on how much debt to issue: Rather than have a certain debt-to-gdp ratio as a desired outcome of fiscal policy, why not argue that fiscal policy and the government?s debt management framework should be geared to keep the interest-to-GDP ratio under, say, 2%?

I?m afraid I don?t have the answer to that one but I think these are worthy ones to put to our politicians:

1. How much debt should a government take on as a percentage of our economic output?

2. For those politicians that believe some amount of debt is appropriate, should we manage that debt in order to keep our interest payments at some sort of low ratio?

UPDATE: Correspondent e-mails to say Paul Krugman told Charlie Rose in 2012 that the right amount of debt is 25% of GDP. Says so here at about 18:10. He says 25% debt-to-GDP is optimal ? remember, Flaherty wants to get us to 28% by FY2018 ? but he says you could live with 100% debt-to-GDP for decades. And says, for the U.S. ?(and this is on Apr 30, 2012) that U.S. shouldn?t worry about that ratio right now.

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Categories: Economy, Politics

Source: http://blogs.canoe.ca/davidakin/politics/where-is-the-line-between-good-debt-and-bad-debt/

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