Stimulus Today and Prudence Tomorrow

The Economist April 25th 2020 pp 7 Leaders “After the disease, the debt” “Governments will owe vast amounts after the crisis. Here’s how to deal with it”

Governments are doing the right thing by borrowing at record levels to relieve the immediate economic consequences of the COVID-19 pandemic. American will run a deficit of 15% of GDP from payouts and shortfalls in tax revenues.

Unlike personal debt, government debt is really borrowing from itself and what matters is the cost of "servicing" the debt. As we all are aware, American interest rates at 1.8% are very low and trending lower. A plus for the U.S. for sure versus some other weaker economies. America also benefits from being the preferred reserve currency which means we readily sell bonds to fund the deficit spending.

After WWII, America faced a similar situation but paid off the loans over decades. This was made possible by time itself and the benefits of sustained industrial growth fueled by innovation and an expanding population. In part, this was also accomplished by suppressing interest rates on issued debt, raising taxes on capital and allowing inflation to erode the cost of debt over time.

Today’s situation is not the same and brings into question the long-term strategy for balancing the books. Somewhat comforting is that economists believe interest rates will remain low for decades but others aren’t so sure and fear “a price-and-interest-rate spiral could get underway as a burst of demand runs up against supply trains that have been wrecked by the pandemic”. Cuts to spending will be difficult, as with an aging population, costs for healthcare etc. are likely to rise while the elderly have no appetite for higher taxes.

Likely paring down the debt, nonetheless, will involve increases in some taxes, some budget cuts and modest inflation over time-“Catch-Up Inflation”. Probable tax targets are inheritance, land, sales and carbon emissions. Cuts will likely target the older and presumably affluent beneficiaries.

Catching up, from “stimulus today and prudence tomorrow” , in part, means avoiding additional crises as well.

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