Are Rising Debt Levels Affordable?
(5 min read)
As governments around the world take on huge quantities of debt in an effort to support their economies, two questions repeatedly arise: won’t all of this borrowing be inflationary? And how will it be afforded and paid back? In this article we address the affordability question.
This is two questions in one. Firstly, is the debt affordable? Many people focus on just one statistic, the ratio of government debt to GDP, a focus given extra impetus by an influential paper issued some 10 years ago by Carmen Reinhart and Kenneth Rogoff in which they argued that national debt dynamics worsen notably once this ratio exceeds 90%.
This figure has the merit of simplicity (and because of this was very widely quoted), but we think it is too narrowly focused. For a country which retains creditworthiness (that is, people do not seriously expect it to default on its debt), the relevant figure is not the absolute level of debt but the debt servicing ratio: how much the debt costs each year. And today’s extremely low interest rates mean that even very elevated levels of debt can be financed with acceptable and sustainable financial cost.
There are several countries where even before the corona-crisis the current level of debt as a percentage of GDP was well above the Reinhart and Rogoff 90% threshold – in Japan it is well over 200% and has been for some time without obvious sustainability issues. And lest current conditions be seen as exceptional, a look at the experience of the United Kingdom shows that at various times in the last 300 years, debt levels have been much higher than they are now.
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