Introduction
The public debt dilemma has been on the news since the start of the pandemic. Indeed, during the time of economic recession, the governments are often tempted to increase national debt in the search for additional funding for covering the deficits in the budget. While there are certain benefits of increasing national debt, significant drawbacks are also possible in the long run. The present paper offers a discussion of theoretical views on the national debt, outlines long-term consequences of increasing national debt, and describes an alternative for addressing budget deficits during the time of economic recession.
National Debt and Theory
National debt may be seen as both a problem and a virtue, depending on the theoretical stance. Keynesian economics, which is considered the most valuable development since the Classical period, demonstrates two benefits of national debt due to recession (Churchman, 2001). On the one hand, increased public spending financed through public debt stabilizes the fluctuating economy due to the countercyclical effect. Public debt allows the government to finetune the investments, which is crucial for stabilizing the economy. On the other hand, as the government increases the spending, it indirectly affects the income of businesses, as they have more customers that can spend money on services and products. This phenomenon is known as the multiplier effect, as increased spending of the public sector multiplies the revenues of the private sector (Churchman, 2001). The supporters of the multiplier effect state that it compensates for the reductions in the tax base due to the stabilization of the private sector (Churchman, 2001). The model, however, has several drawbacks that can be explained by the Ricardian model.
David Ricardo created a theory based on the notion of the Ricardian Equivalence. This idea supposes that a person makes a decision to purchase based on the present income level, but also on the anticipation of future spending (Churchman, 2001). People may anticipate that due to the rise of national debt, the government will have to repay it using increases in taxes. Due to the anticipation of future tax expenses, people may want to withhold some of their capital that was acquired due to increased government spending to stabilize the economy (Churchman, 2001). As a result, the multiplier effect does not come into play, as the money becomes stored in banks instead of circulating in the economy. The idea of Ricardian Equivalence has met much criticism, as theorists disagree about people making their decisions based on the anticipation of future spending (Churchman, 2001). Nevertheless, the model attracted much attention from modern theorists.
Another economic theory that discusses the problem of the national debt is the Modern Monetary Theory (MMT). The core of this theory lies in the assumption that the government can increase debt as needed for any cause, as central banks can issue new money without limits (Whittaker, 2020). The only limit to this spending is the level of inflation, which can be regulated through taxes (Whittaker, 2020). However, monetary conservatives state that inflation increases due to too much money in the economy and the common belief that large national debts are ruining the economy (Whittaker, 2020). In summary, the theoretical views on the national debt are controversial.
Long-Run Costs of High National Debt
The central problem of the high national debt is the increased national interest expenses. According to Peter G. Peterson Foundation (PGPF, 2020), the US government’s interest expenses will reach $5.4 trillion in the coming ten years. As a result, the government will have less money to spend on public needs, such as education, public health, and security. As a result of underinvestment in education, the national will have a lower-skilled workforce, which will negatively affect the efficiency of the economy. Underinvestment in national security can cause threats to national stability and defense from outside threats.
Higher national debt will negatively impact the wages of the public sector employees, which in term will have an indirect negative impact on the private sector as well. Thus, the citizens of the country will have fewer opportunities and less access to services. Increased national debt also affects interest rates, which implies that fewer people will be able to afford new houses, cars, and education (PGFF, 2020). In other words, people will become less happy with the current government policy, which may also cause political instability.
Finally, increased national debt may cause significant problems with fiscal stability in the country. The investors may lose confidence in the national fiscal position, which will lead to increased interest rates to offset the perceived risks (PGFF, 2020). An increase in Treasury rates can cause higher-than-expected inflation. Such events can start a chain reaction, as the value of outstanding government securities will decrease, which will cause losses of shareholders, including mutual funds, pension funds, insurance companies, and banks. Losses of these shareholders can further destabilize the national economy. Thus, high national debt has a negative long-term impact on the economy and the individuals of the county.
Alternatives
Budget deficits can also be eliminated through personal tax increases and through spending cut by decreasing in transfer payments. The consequences of both alternatives to increases in debt have been partially discussed above. On the one hand, PGFF (2020) states that a decrease in funding of education, health, and security can lead to significant problems in these spheres. In particular, the decreases in transfer payments can reduce national health, security, and education level, which will result in a less efficient economy in the long run. In the short-term, decreased spending will lower the wages of the public sector and decrease the income of people dependent on financial support from the government. As a result, less money will be circulating in the economy, which will affect every aspect.
On the other hand, increases in taxes will discourage people from working more, as they will have to pay a large part of their revenues (Alesina et al., 2018). Additionally, higher tax rates will discourage savings and negatively affect private investments in the national debt (Alesina et al., 2018). Recent research demonstrated that countries utilizing spending cuts demonstrated higher economic performance in comparison with those that selected to raise revenues through tax increases (Alesina et al., 2018). However, such policy may be negatively met by the public, which is crucial for political stability.
Conclusion
Economic recessions are always a trilemma for governments. There is always a possibility to raise capital through increasing national borrowings, decreasing spending, or raising the tax rates to address budget deficits. While there are benefits of every approach, there are also long-term drawbacks that should be considered. The analysis conducted in the present paper demonstrated that there is no panacea for addressing the problem of budget deficits during economic recessions. Thus, every government should apply the policy that is most suitable for every specific situation based on the results of situation analysis.
References
Alesina, A., Favero, C., & Giavazzi, F. (2018). Climbing Out of Debt.Finance and Development, 55 (1), 7-11. Web.
Churchman, N. (2001). David Ricardo on Public Debt. Palgrave.
Peter G. Peterson Foundation. (2020). The Fiscal & Economic Impact of the National Debt.Web.
Whittaker, J. (2020). Modern monetary theory: the rise of economists who say huge government debt is not a problem. The Conversation. Web.