In 2019, former International Monetary Fund chief economist Olivier Blanchard used his last speech as president of the American Economic Association to put forward a provocative yet simple idea: In a world where interest rates are very low, governments can afford to take on more debt.
The gist of his argument: As long as the economy is growing at a rate faster than the interest rate on government borrowing, financing debt should be sustainable.
Fast forward three years — Governments around the world borrowed trillions to combat a global pandemic that walloped their economies and are now faced with rising interest rates to combat soaring inflation. In the U.S., fiscal responsibility is back in vogue — Sen. Joe Manchin (D-W.Va.) has pushed for deficit reduction, a message also embraced by the White House, which needs Manchin’s support to salvage its social spending agenda.
Blanchard, who has a forthcoming book, Fiscal Policy Under Low Interest Rates, chatted with MM about U.S. debt, the Biden administration’s Covid response and the role of fiscal policy in combating inflation. (He’ll discuss the book at an event today hosted by the Peterson Institute for International Economics, where he is a senior fellow.)
The following conversation has been edited for length and clarity:
You said in a recent magazine piece, give me a specific country in a specific time and I’ll tell you whether the level of debt is safe right now. So what is your view of U.S. debt?
“I don’t worry about U.S. debt. There is going to be a bump in real rates due to the need to decrease inflation, but after this, we should go back to a world in which the real rate remains negative, or zero. So in that context, you can clearly afford more debt. It’s not the end of the world, even when you take account of the uncertainty. So if we need to have larger deficits for a good reason, then it’s fine.”
“I’m not against debt, but it has to be used for the right reason.”
Sen. Joe Manchin has raised concerns about new spending programs that may add to deficits over the coming years. Is he right to be concerned?
“I think he’s partly right. If we are going to have to spend more, there’s no particular reason not to make us, the American taxpayers, pay for it now. There’s no reason to basically push it to the future. For example, child care — I’m very much in favor of child care, I think child care is absolutely essential. Why should it not be financed by taxes? Why should it be financed by debt? What is the argument for delaying the cost to future generations? I don’t see it.”
“I think that this administration got derailed at the beginning in doing too much and in not worrying enough about the macroeconomic effects on the economy, the overheating and the inflation. I think that they went too far.”
Do you think deficit reduction should be a priority right now?
“Deficits are going to come down because some of the pandemic spending is going to go away. But we should try to prevent very large deficits going forward, if they are not justified. In the U.S., the primary deficits even before Covid were too large. There is no question. So we have to have a plan, such that at least we don’t increase debt or the debt ratio.”
Senator Manchin has also argued that we should reduce deficits now because inflation is high. Do you agree?
“These are two completely different issues. We need to reduce inflation because we don’t want too high inflation.”
“Inflation comes from demand today, and we basically have to slow down demand now. And that’s what the Fed has to do. We can have a discussion about whether inflation will come down on its own, whether the Fed will have to tighten and increase interest rates a lot. But that has absolutely nothing to do with Build Back Better. BBB is relevant to what happens in the next 10 years.”
“If I were him, I would make the argument that, if we’re going to do good things for people, we should pay for most of it today. Which seems to me to be a much better argument than saying, oh, inflation is high.”
Is there a role for fiscal policymakers to play to help bring down inflation?
“My sense is the Fed is still the primary mover, because it is the one which says it wants to achieve 2 percent inflation. So that hopefully gives people a sense of where the Fed is trying to go, and that affects expectations.”
“The other way to slow down inflation would be with a dramatic deficit reduction, a big tax increase, and people would spend less. This would increase unemployment, which would lead to less wage pressure, less price pressure. But how to control demand and bring inflation under control can be done much better by the Fed. In this case, fiscal policy should not stand in the way, one way or the other, either by being too tight or being too loose.”
Read the original article on the site of Politico.