A number of economists have
recently called on the Eurosystem to cancel the public debts on its
books, claiming that this operation would be painless and would give
governments much needed room for maneuver on the fiscal front. Jef
Boeckx and Xavier Debrun show that debt cancellation would be useless,
costly and risky. It is useless because the debt of the consolidated
public sector would not change, while the budgetary impact would be nil.
It is costly because the government would still pay for a supposedly
canceled debt in the form of lesser dividends from their central banks.
It is risky, because destroying assets that back money issuance is akin
to debasement, potentially undermining confidence in the currency.
The abysmal fiscal deficits caused by
the COVID-19 pandemic are certainly worrisome. Do they carry the seeds
of prolonged future austerity to pay off the Himalayan public debts left
by the crisis (and for many countries, decades of relative fiscal
profligacy)? How will governments square the debt burden with the need
to pay for inexorably rising retirement benefits, ambitious climate
change mitigation policies, high-quality education, and
productivity-enhancing public spending programs?
Answers to these essential questions
will shape the welfare of present and future generations. Clarity is
therefore a must. Unfortunately, misleading arguments based on the
always dubious principle that there must exist simple “common sense”
solutions to complex problems regularly distract us from the real
trade-offs.
One much-debated proposal is to write off all
government bonds currently on the books of the Eurosystem (i.e. the ECB
and national central banks of the euro area). The potential impact is
dizzying. For instance, in Belgium alone, that would amount to about 120
billion euros of debt instantly purged from public sector’s
liabilities. According to its supporters, this operation would be
painless and would give governments much needed room for maneuver on the
fiscal front.
That kind of argument reflects a profound
misunderstanding of the nature of central banks and their main function:
the creation (and destruction) of money. We will skip over the fact
that such cancellation would be illegal (debt monetisation is
effectively prohibited by European treaties) to focus on its economic
uselessness, its costs, and the risks it entails.
Useless
Debt
cancellation is a solution in search of a problem. Euro area
governments can easily borrow considerable amounts at rates close to
zero or negative, and this even for long maturities. Hence, even very
high debts do not come in the way of ambitious fiscal policies. Not only
maturing debt can be seamlessly rolled over, but interest payments
leave an insignificant footprint on the annual budget. For instance,
Belgium, despite chronically posting public debt ratios in the triple
digits for most of the last 50 years, devotes less than 4 cents out of
every euro of government revenue to cover interest payments. This pales
in comparison to the 23 cents allocated to retirement benefits and the
more than 26 cents spent on civil service wages. So, if space is to be
found in the budget, the “easy” way out seemingly offered by debt
cancellation is nothing but an illusion.
The obvious
counterargument is that interest rates are bound to rise in the
foreseeable future, prematurely squeezing the fiscal space available for
continued support to a sustainable recovery. Such concern is overblown.
The considerable lengthening of average debt maturity since the advent
of very low rates has made it possible to preserve the benefit of cheap
borrowing costs for some time, ensuring the sustainability of current
debts even if rates were to rise. Besides, rate increases would not be
of the sudden, uncontrolled type driven by random shifts in market
beliefs. Since 2012, the European Central Bank has made it clear that it
would coordinate expectations away from such “bad equilibria.” As long
as governments are committed to pro-growth fiscal measures, structural
reforms, and safe debt levels in the long term, “fundamental” solvency
issues can be kept at bay.
Thus, blind austerity, which is not
desirable during a fragile and uncertain recovery, is not necessary
either. Instead, an "organic" reduction of the debt ratio is achievable
through the power of growth compounding: over 20 years, an average real
GDP growth of 1.5% combined with 2% inflation contributes to halving any
given inherited debt ratio. Once again, this can be done unless
governments make the preventable mistake to pander to low quality fiscal
measures (often political quick wins) and send the wrong signals about
their commitment to manageable debt paths in the longer term. Any
pre-crisis structural budgetary imbalance should be handled by
compressing unproductive outlays. Between the staggering largesse of the
Biden plan and the dogmatic austerity advocated by others, there is
indeed an ocean.
On a slightly more technical note, let
us also recall that the central bank, regardless of its operational
independence in the conduct of monetary policy, is part of the broader
public sector. Hence, government debt cancellation by the monetary
authority has no impact on the public sector consolidated balance sheet,
a fact that feeds into the next argument....
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