Public-sector debt is spiralling in high-income countries. But this is no cause for panic. Governments are right to borrow freely during the Covid-19 crisis. The debt will also remain affordable — provided they take the trouble to lock in today’s ultra-low interest rates.
Average government financial liabilities are expected to jump to more than 137 per cent of gross domestic product in high-income countries this year, similar to the current level in Italy. That will be just the beginning. But it is the role of governments to spend and borrow in a crisis of such magnitude.
Fortunately, the manageability of debt depends on its cost, not its size. Today, governments of high-income countries can borrow ultra-cheaply, partly because private spending has collapsed, partly because people are looking for safety, and partly because central banks are purchasing so much.
As of Friday, nominal rates of interest on 30-year debt ranged from zero in Germany to 0.5 per cent in Japan, 0.6 per cent in the UK, 0.8 per cent in France, 1.4 per cent in the US and 2.4 per cent in Italy. The real interest on the UK’s 30-year index-linked securities was minus 2 per cent.
The ability to borrow so cheaply for long maturities allows governments to eliminate the risk of having to pay higher interest rates for decades. Indeed, they could even eliminate the risk altogether: in the 19th century, the UK issued irredeemable debt. Borrowing long will impose a small additional cost: in the UK, for example, the yield on the 50-year gilt is 0.25 percentage points higher than on the 10-year. Yet this is surely a tiny price to pay for the insurance offered by being able to borrow at such low rates for so long.
The case for borrowing ultra-long has been strong for some time. It is stronger still today, since rates are so low and indebtedness is going to jump. Yet the average maturity of outstanding US debt was under six years at the end of 2019.
At just over 14 years, the UK’s average maturity was the longest in the Group of Seven leading economies, with the other countries clustering between just over six and just over eight years. Borrowing at short maturities seems a little cheaper now. But it is a false economy. If, as is likely, real and nominal interest rates rise over time, these countries might be driven into a fiscal crisis and inflationary finance.
Governments should not just finance — and refinance — their debt at ultra-long maturities. They should also borrow as much as they can on inflation-protected terms. This would not just lock in today’s ultra-low real rates, but would also reinforce their commitment to keeping inflation low in future, since governments could not then benefit from inflicting inflation surprises.
The fact that central banks are buying a great deal of the debt today does not change the case for governments to borrow at long maturities. At some point, the central banks may sell some or all of the debt they hold. If rates of interest are higher then, they will make losses. This is unimportant. Central banks are not commercial ventures.
Given today’s interest rates, governments do not face any constraint on borrowing. The market is almost paying them to do so. Moreover, that is what governments are also supposed to do in a crisis. Provided they lock in low rates and bring fiscal deficits back under control once the crisis has gone, they will find their vastly expanded debts affordable in the future, too.
The opportunity to borrow so cheaply is the other side of a disaster. Yet it offers governments the closest they may get to a free lunch — though one that is unlikely to last. They should order their meals now for years ahead.
