Sufi and two other economists, drawing partly on work by Vissing-Jorgensen and others, estimate that the United States still had some fiscal space — i.e., was short of the tipping point — in late 2019. There’s been a huge increase in debt since then, but the authors aren’t prepared to say that the increase has pushed the United States past the tipping point. One offsetting factor is that the pandemic caused people to spend less, leaving abundant savings for the bond market. In the longer term, increased inequality increases savings rates (since rich people save more than poor people), so it allows the government to borrow more without satiating lenders.
Markus Brunnermeier of Princeton University said one explanation for the low-yield puzzle is that Treasuries are in demand because of their unique role as “a safe asset that hedges against uninsurable risk.” Ricardo Reis of the London School of Economics said, “there’s a lot more fiscal space out there than might have been appreciated before,” but it’s not unlimited.
I followed up with Atif Mian of Princeton, who is collaborating with Chicago’s Sufi and Ludwig Straub of Harvard University. Mian said that in celebration of the new year he had T-shirts printed for himself and his co-authors featuring their mathematical formula for debt sustainability. (He said they’re not for sale, alas.) Mian said that the three of them are trying to put debt sustainability into quantifiable terms so that people from the left, center and right of the deficit debates “stop talking past one another.”
In a now-famous article published in the American Economic Review in 2010, Carmen Reinhart, then of the University of Maryland, and Kenneth Rogoff of Harvard reported that the average growth rate of countries with public debt exceeding roughly 90 percent of their gross domestic product was several percentage points lower than it would have been at lower debt levels. But a 2014 paper by researchers at the International Monetary Fund questioned the 90 percent threshold and found that “countries with high but declining debt appear to grow equally as fast as countries with lower debt.”
Modern Monetary Theory says that the federal government of the United States never has to worry about paying what it owes because it can always print more money. The only concern of adherents of the theory is that too much government spending (or too little taxation) could overheat the economy, causing inflation. Mian said supporters of the theory have “an intuition that is correct under certain conditions. But because it’s not spelled out, we don’t know what the limits of that intuition are.”
In a sharp economic downturn such as in the spring of 2020, “you can always run a big deficit temporarily,” Mian said. In fact, he said, it’s exactly the right thing to do. “The problem is with long-term, steady-state projections.” To retain the faith of investors that the debt is sustainable, the government might have to cut spending or raise taxes. The scary though relatively unlikely scenario, Mian said, is that a dysfunctional government in the future would fail to do those things. “Anyone who claims they know exactly how those dynamics will happen would be lying.”
Reis reminded me that sovereign debt crises tend to be self-fulfilling prophecies: Investors get nervous about a government’s ability to pay, so they demand higher interest rates, which raise borrowing costs and produce the bad outcome they feared. It’s a dynamic that Argentines are familiar with — and that Americans had better hope they never experience.