Brad DeLong (the full post is much, much longer):
Needed: More Government, More Government Debt, Less Worry: **Introduction**
Olivier Blanchard, when he parachuted me into this panel, asked me to “be provocative”.
So let me provoke:...
It makes sense to distinguish the medium from the short term only if the North Atlantic economies will relatively soon enter a régime in which the economy is not at the zero lower bound on safe nominal interest rates. The medium term is at a horizon at which monetary policy can adequately handle all of the demand-stabilization role. ...
As I see it, there are three major medium-run questions that then remain...:
* What is the proper size of the 21st-century public sector?
* What is the proper level of the 21st-century public debt for growth and prosperity?
* What are the systemic risks caused by government debt, and what adjustment to the proper level of 21st-century public debt is advisable because of systemic risk considerations?
To me at least, the answer to the first question–what is the proper size of the 21st-century public sector?–appears very clear.
The optimal size of the 21st-century public sector will be significantly larger than the optimal size of the 20th-century public sector. Changes in technology and social organization are moving us away from a “Smithian” economy, one in which the presumption is that the free market or the Pigovian-adjusted market does well, to one that requires more economic activity to be regulated by differently-tuned social and economic arrangements (see DeLong and Froomkin (2000)). One such is the government. Thus there should be more public sector and less private sector in the 21st-century than there was in the 20th.
Similarly, the answer to the second question appears clear, to me at least.
The proper level of the 21st century public debt should be significantly higher than typical debt levels we have seen in the 20th century ... *unless interest rates in the 21st century reverse the pattern we have seen in the 20th century, and mount to levels greater than economic growth rates*.
This consideration is strengthened by observing that the North Atlantic economies have now moved into a régime in which the opposite has taken place. Real interest rates on government debt are not higher but even lower relative to growth rates than they have been in the past century. Financial market participants now appear to expect this now ultra-low interest-rate régime to continue indefinitely (see Summers (2014)).
The answer to the third question–what are the systemic risks caused by government debt?–is much more murky. ...
The question ... is:... How much more likely does higher debt make it that interest rates will spike in the absence of fundamental reasons? How much would they spike? What would government policy be in response to such a spike? And what would be the effect on the economy?
The answer thus hinges on:
* the risk of a large sudden upward shift in the willingness to hold government debt, even absent substantial fundamental news.
* the ability of governments to deal with such a risk that threatens to push economies far enough up the Laffer curve to turn a sustainable into an unsustainable debt.
I believe the risk in such a panicked flight from an otherwise sustainable debt is small. I hold, along with Rinehart and Rogoff (2013), that the government’s legal tools to finance its debt via financial repression are very powerful, Thus I think this consideration has little weight. I believe that little adjustment to one’s view of the proper level of 21st-century public debt of *reserve currency-issuing sovereigns with exorbitant privilege* is called for because of systemic risk considerations.
But my belief here is fragile. And my comprehension of the issues is inadequate.
Let me expand on these three answers...