“Debt is politically attractive”
Prof. Felbermayr, in the German debate about the debt brake, two economic schools face each other: those who want to reform or suspend it to secure or even increase future growth through debt-financed investments. And those who believe that the state already receives enough money just need to distribute it better, especially since any borrowing today is a burden for the generation of tomorrow. Which school would you classify yourself at? And why?
I have problems with “schools”. Especially since there are often no simple solutions to complex questions. I am convinced that a debt brake is needed, but it needs to be reformed so that the expansion of the public net capital stock can be financed by debt. But I am also convinced that the state quota is too high and that the public sector has more financial leeway than it claims if only it were prepared to set priorities.
There are always enough voters who prefer higher government debt to a higher tax burden or lower social benefits.
So far, the debt burden has only fallen slightly in short periods. Inflation contributed most to this. Why do people still believe politicians’ debt reduction promises?
Debt is politically attractive because it appears to allow the burden of expanding government activities to be shifted to future generations who are not currently allowed to vote. There are probably always enough voters who prefer a higher national debt to a higher tax burden or lower social benefits.
The interviewee: Gabriel Felbermayr has been director of the Austrian Institute for Economic Research (Wifo) in Vienna since October 2021 and a university professor at the Vienna University of Economics and Business (WU). The 47-year-old Austrian previously made a name for himself in economic research in Germany, including as President of the Kiel Institute for the World Economy (IfW Kiel) and head of the Ifo Center for Foreign Trade at the Ifo Institute in Munich.
An entire body of economic theory – the Modern Monetary Theory (MMT) – is dedicated to the thesis that more debt is ultimately good for the state and society. How do you come up with that? And how do you classify that?
I'm not a fan of this theory. Their idea is that an underutilized economy can be brought to full capacity through debt-financed government spending and that this is possible without limits because the central bank guarantees the national debt. If the demand stimulation goes too far and inflation occurs, then according to the theory, taxes should be increased to curb inflation again by reducing private demand. The problem with this vulgar Keynesian theory is that it is difficult to apply to the current context. Most EU economies are not underutilized, especially Germany, where unemployment is deficient. Furthermore, the theory is not compatible with an independent central bank.
It is distribution policy conflicts rather than macroeconomic debt sustainability that sets limits on debt taking.
It seems to be a kind of law of nature: national debt continues to increase worldwide - going back seems unthinkable. How much debt can countries actually carry?
This is not so easy to say quantitatively; Various research attempts to find generally valid limit values have failed. Japan has no big problem with a national debt of over 260% of gross domestic product (GDP). However, most developing countries reach massive limits when their debt levels are below 50%. In addition, the private debt of national economies can be at least as big a problem. The question is more: How much debt do the younger generations want to endure? It is distribution policy conflicts rather than macroeconomic debt sustainability that sets limits on debt taking.
Is there – analogous to climate theory – a systemic tipping point beyond which debt inevitably gets out of hand?
Financial markets are always about trust in a debtor's future solvency. If this breaks, for whatever reason, then a debt crisis will occur because the state can no longer service the existing debts. Crises of trust can occur very abruptly. And because creditors try to reduce their claims before the debtor actually becomes insolvent, a crisis can occur before the fundamental economic variables force it. However, this only happens if the state takes on debt in a currency that it does not issue itself.
When central banks buy up government debt, it keeps the country liquid, but it can easily lead to inflation crises.
Ultimately, debts are just balance sheet items that can be moved. Many central banks demonstrate this in an exemplary manner by repeatedly buying up government debt. Would that be a way to avoid a haircut that is actually necessary?
This mechanism only keeps states liquid so that they always remain solvent. This can work for a while.
So, it's definitely not permanent. And what would be the consequences for economies?
The monetization of public deficits can easily lead to inflationary crises. Therefore, the direct purchase of government debt in the Eurosystem is actually prohibited.
If public deficits are hidden in the central bank balance sheet, the debts formally disappear, but the associated real economic demands remain in the system.
Once on the central bank's balance sheet, they could simply shut down the national debt included in the balance sheet. A kind of silent currency cut …
That helps the finance ministers but not the national economies. The debts only disappear formally, but the associated actual economic demands naturally remain in the system. However, when government debt is monetized, the risk of inflationary crises always remains.
If we look back in history, there were regularly new beginnings due to excessive indebtedness. Is this inevitable?
Such episodes were almost always associated with massive economic and political crises that entailed enormous economic costs. The aim of economic policy must, therefore, be to avoid such circumstances at all costs. This is why a sensible, rule-based budget policy is so important.
A mechanism was once found in the USA: the federal states were relieved of their debts at the beginning of the republic and have been categorically not allowed to incur any new debts since then. A path for a new beginning for the Eurozone?
Yes, that would be an option. But the question is always whether a bailout in a crisis can really be credibly ruled out. This is only possible in the USA because, in addition to the federal states, there is also an overall state with a large budget that can guarantee the functioning of the community even in a bankrupt federal state. This condition does not exist in the EU. If you want to go the US route, you would have to significantly expand the central budget and give the EU Parliament budget rights.
Stephan Lorz asked the questions.
