April 17, 2021

How much should we borrow?

2 min read
A commenter directed me to a Noah Smith post that begins as follows: One of...

A commenter directed me to a Noah Smith post that begins as follows:

One of the most important questions in macroeconomics is one that economists have curiously chosen not to study. That question is: “How much can the government safely borrow?”

In my view, this is the wrong question.  The right question is: How much should the government borrow?

The term “safely” is quite vague.  Safe from what?  From default?  From hyperinflation?  From future tax rates that are punishingly high?

In contrast, we have a great deal of research on the optimal level of public borrowing.  In a 1979 JPE paper, Robert Barro argues that the budget deficit should fluctuate in such a way as the minimize the long run deadweight cost of taxation.  Here is the abstract:

A public debt theory is constructed in which the Ricardian invariance theorem is valid as a first-order proposition but where the dependence of excess burden on the timing of taxation implies an optimal time path of debt issue. A central proposition is that deficits are varied in order to maintain expected constancy in tax rates. This behavior implies a positive effect on debt issue of temporary increases in government spending (as in wartime) a countercyclical response of debt to temporary income movements, and a one-to-one effect of expected inflation on nominal debt growth. Debt issue would be invariant with the outstanding debt-income ratio and, except for a minor effect, with the level of government spending. Hypotheses are tested on U.S. data since World War 1. Results are basically in accord with the theory. It also turns out that a small set of explanatory variables can account for the principal movements in interest-bearing federal debt since the 1920s.

Can we safely borrow as much as we are currently borrowing?  I’d say yes.  Should we be borrowing as much as we are currently borrowing?  I’d say no.  After all, I don’t think anyone in their right mind expects a “constancy in tax rates” in the coming decades.  Tax rates are going to increase.

PS.  If you don’t believe that tax rates are set to increase, consider today’s news:

House Republicans voted to allow their members to request dedicated-spending projects, known as earmarks, following that same move by Democrats, in a positive sign for President Joe Biden’s hopes for a bipartisan infrastructure bill.

So remind me, which one is the party that favors small government?


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