Updated 5 pm, 30 March 2020
Much is uncertain about the Covid-19 crisis, but two things are clear: government debt is about to become much bigger, and there’ll be no shortage of commentators who will say that’s a problem.
G20 governments have collectively announced more than $5 trillion in fiscal stimulus, with more to come. The Australian government’s measures, including yesterday’s $130 billion spending package, are broadly in line with other countries. So should we be worried about the consequent growth in government debt?
The answer is a clear and resounding no. Whether this new debt is justified depends on the benefit of the increased spending versus the cost of that spending and, in the current environment, the benefit is substantial while the costs are minimal.
Fiscal stimulus will avoid the current crisis turning into an economic catastrophe, a fact that appears to be well understood by the public. The lesson from the Great Depression is that my spending is your income, and your spending is my income. If we all stop spending at our local restaurants, the owners and workers in those restaurants lose their income. They spend less in other businesses, which lose their income too, producing a vicious downward spiral that ends in economic collapse. The solution is for the government and Reserve Bank to step in and substantially increase spending and support businesses to fill the gap until the private sector recovers.
Failing to expand government significantly would have catastrophic long-term consequences: huge increases in the number of unemployed people (many of whom will never work again), the destruction of thousands of healthy businesses (many of which will never recover), and the permanent destruction of income, wealth and the earning potential of our young people, to say nothing of increased suicides, increased mortality among the very young and very old, increased domestic violence, increased attacks on minority groups, the rise of political extremes and the increased probability of war. The benefits of increased spending are simply enormous.
Conversely, the costs of increased government spending are very low. These costs typically come in three forms.
The first is the potential for increased government spending to “crowd out” the private sector. When governments run budget deficits they are borrowing money from investors, money which is no longer going to other worthy investments. Increased demand on the limited pool of savings, in normal times, means higher interest rates (which make it more expensive for businesses to invest and households to borrow) and an appreciated exchange rate (making our exports more expensive than those from other countries). The increased government spending stimulates inflation, meaning higher prices for all of us. In normal times, then, increased government spending can hurt businesses, households and individuals.
But these are not normal times. Even before Covid-19 the world was awash with savings, which is why interest rates and inflation were so low. The current crisis means even more savings, even less demand for those savings and even lower interest rates and inflation, and an exchange rate that’s less responsive to increased government spending. Put simply, the costs of increased government spending in normal times do not apply.
The second potential cost of increased government spending is the future cost of paying interest on that debt. This is minimal in the current environment. The interest rate the Australian government pays on new debt is at its lowest level in history — just 0.8 per cent for money borrowed for ten years. Households and businesses can only dream of being able to borrow that cheaply. This is why it makes perfect sense for the burden of stimulating the economy to be placed on the government since it can borrow so much more easily and cheaply than households or businesses. This is also why it makes no sense to be asking households to access their superannuation (especially given they are already losing their jobs, taking wage cuts and watching their super balances plummet) or asking small businesses to take out loans (whether profit-contingent or otherwise). Stimulus should come from the lowest-cost supplier, and that’s the government.
Some might worry whether this increase in debt would mean higher taxes in the future, but there is no reason this needs to be the case. The reason a $10 million debt is a bigger problem for me than it is for Gina Rinehart is the same reason economists look at debt as a percentage of GDP — the denominator matters. The best strategy for reducing debt is to generate economic growth. The maths is simple. If the Australian economy resumes its long-run average growth rate after the current crisis, any increase in debt as a percentage of GDP will halve within twenty years. People would need to start having kids very early in life for this to become an intergenerational debt burden.
The third cost of increased government spending is that it can be unsustainable (meaning it can cause problems if that level of spending continues) or can destabilise financial markets. The sustainability of Australia’s current increase in spending is not a concern because it is temporary and doesn’t change the long-run growth rate of debt. Financial stability is not a concern given Australia’s debt is seen as a safe-haven by financial markets: this is why investors are willing to accept pathetically low interest rates for the honour of being able to finance our debt. Even if private investors stopped financing the government’s debt, or charged prohibitively high interest rates to do so, the Reserve Bank would take over that debt, safe in the knowledge that inflation is non-existent and the debt is denominated in our own currency.
All of this means that Australia won’t come out of this crisis with a debt problem. The International Monetary Fund ranks Australia’s fiscal position as being in the highest category possible, meaning there is ample room to substantially increase spending. The Australian government could increase debt by three-quarters of a trillion dollars — far more than anyone is suggesting — and still have less debt as a percentage of our economy than the average among its G20 peers.
Sadly, this will not prevent a flood of commentators and politicians in the coming months warning of an impending debt crisis in Australia. As soon as the health crisis shows the faintest sign of abating, or perhaps even before then, the government will face tremendous political pressure to cut spending and pay down debt. It is no doubt already facing calls to limit stimulus out of fears of future debt. To protect the living standards of Australians, it must withstand this deeply misguided advice. •