The Economics and Ethics of Government Default, Part I
The problem of government deficit spending and the resulting public debt is a challenge to most modern economies. A few states, such as Germany, with a reputation for fiscal austerity, operated with budget surpluses and declining debt, but that was before the coronavirus gave governments everywhere an excuse to massively extend their powers and increase spending. Now it looks like all nations will have to carry the heavy load of paying off enormous government debts contracted in the pursuit of destructive policies. The average net government debt, i.e., debt not owed to some agency of the issuing government, of advanced economies topped 96 percent of GDP in 2020, and there are no signs that governments will stop borrowing.
Figure 1: Net Debt of Select Economies, 1990–2020
Source: IMF. The flat line for the US prior to 2000 is a period of no data.
Across Europe, there is a growing sentiment that public debts are nothing but a burden and should be canceled. Most recently, a group of leftist economists have published a manifesto suggesting that the public debt held by the European Central Bank—at present €2.5 trillion—be written off. This manifesto, however, is simply a thinly disguised plea for inflationary financing of leftist pet projects: not only should the ECB cancel government debts, but the governments should also commit to spending an equivalent amount on a “widespread social and ecological recovery plan.” Although the source of funding for this spending is not specified, realistically it must be borrowed, and the only institution willing and capable of lending such amounts to governments is the ECB.
My objective in this three-part series is not to criticize the suggestions of the manifesto writers, pleasurable though such a task might be. Rather, it is to seriously investigate the problem of government debt and in particular the consequences of government default. What would it mean for the economy if by one fell swoop not just the debt owed to the central bank, but all of it disappeared? I’m not giving too much away if I now reveal that, like Peter Klein and J.R. Hummel, I think that government default would be a great boon to the economy long term.
The idea of solving the debt problem through default is generally considered beyond the pale by all respectable people. As they see it, there are only two alternative solutions: either using inflation to destroy the real value of the debt or introducing economic reforms that lead to an increase in tax revenues, which in turn make paying off the debt manageable. The European manifesto writers therefore deserve credit for raising the idea of debt repudiation.
Before going on to the question of the economic effects of government default, however, we need to first consider the ethical side of things. Economists are loath to accept this, but all policy proposals are inherently normative. It is not possible to act simply as a neutral advisor or to merely suggest policies in the
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