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Should Governments Spend Away?

With sovereign-bond markets still showing little concern for the massive levels of borrowing and spending across advanced economies, it is tempting to think that there is effectively no limit to further stimulus. But we owe it to future generations to recognize how spending today could affect investment tomorrow.

CHICAGO – Advanced economies have already spent enormous amounts providing pandemic relief to households and small- and medium-size businesses. The International Monetary Fund’s June outlook estimates that, including fiscal measures and credit guarantees, spending reached approximately 20 percentage points of GDP. In the United States, Congress is considering new spending ranging from 5% of GDP (Republicans) to 15% (Democrats). And still more government spending, and thus borrowing, will be needed by the time the pandemic is behind us.

Economists have argued that current low interest rates mean that sovereign debt remains sustainable at much higher levels than in the past. They are right, provided that nominal GDP growth returns to a reasonable level, interest rates stay low, and future governments limit their spending. Even if the first two assumptions hold true, the third behooves us to assess the quality of current spending.

In normal times, responsible governments aim for a balance over the course of the business cycle, repaying in upturns what they borrow in downturns, with the cohorts that benefit during the first phase repaying during the second. There is, however, no chance that the massive debts accumulated during the current crisis will be repaid soon. Even with higher taxes on the rich – a policy that will meet with intense opposition and arguments against growth-stifling austerity – a large share of the accumulated debt will be passed on to future generations.

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