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What you're saying is of course true, assuming 3% real GDP growth. My concern is the debt:GDP ratio at which we would like to stabilize. A lower ratio puts us at lower risk to shocks in GDP, and demographic changes that may require higher levels of spending. I don't see the need to repay debt in a big way, but I'd still like to see the debt:GDP decline a bit further.

I wish that we used recessions as opportunities for governments to spend without crowding out private spending. Infrastructure is a great area of opportunity, but requires diligent planning and execution to get underway while the economy is still in recession. I'm not comforted by the fact that can probably afford to spend a great deal on dubious tax credits when we have a $125 hole in maintaining existing infrastructure in addition to a need for $125 in new infrastructure. At least people can save 15% on resodding their yards.

It feels like you're twisting things a bit; that this $50b deficit is only as big as previous $25b deficits. But those were really $12.5b deficits, no? The numbers themselves mean little to me - it's the relative values compared to previous deficits that matter.

Andrew: Yes, it might be a good idea to try to get the long run debt/GDP ratio down a bit further. But unfortunately there really isn't much in the way of theory to tell us what the optimal debt/GDP ratio is.

Tom: I see your point. But the sort of adjustment I am talking about would not be a halving of previous deficits. It would mean an even bigger absolute downward adjustment to some previous deficits. We have been running surpluses (as normally defined) so the debt was bigger in the past. So 5% of a bigger debt would be a bigger downward adjustment than the current $25 billion downward adjustment. So a previous $25 billion deficit was probably a $5 billion surplus (if the debt was $600 billion at the time).

Hang on - what about interest payments? If you net these out of the story it doesn't sound so good, because inflation will feed through to interest payments. Say my accumulated debt is 100% of GDP then the interest burden is MORE than the rate of inflation so the "deficit" excluding interest must be a surplus.

reason: if you had a sudden increase in inflation, then the debt/GDP ratio would start to fall, as nominal GDP rose more quickly with inflation, but it wouldn't be sustainable. Eventually when nominal interest rates on the debt increased too, by the same amount, the debt would start rising more quickly too.

But we have had an average 2% inflation for about 18 years now, long enough for it to be built into expected inflation and the interest rates on most government debt. There's a little bit of old debt still around that was issued when inflation was higher than 2%, and so has higher interest rates. When that old debt eventually gets paid off, and replaced with new debt at lower interest rates, the debt/GDP ratio will start falling. I have ignored that effect.

Way too many assumptions to count, not least reason's point on interest rates but also that politics governs government program growth and the collection of revenue to pay for both them and the accrued debt. There is also, in Canada's case, the lower levels of government and their debt loads to consider.

@Nick - Canada is fortunate in that unlike say Ireland it is not yet in danger of losing top grade investment rates. But how long can Ontario's industrial base, our nearest neighbour (and especially MI and Western NY) and Canada's export markets generally take a beating before the rating agencies start looking at us in askance, especially when unlike Chile we have a federal government that was unwilling to pay a political cost to stock the storehouse in good times?

Nick, I was about to jump on the interest rate thing but reason beat me to it. I can't get on board with this thinking, it's strikes me as unbelievably dangerous. As soon as I read the word "forever" ("So you can run a deficit equal to 2% of the debt forever") I literally cringed. De Beers propaganda, nothing is forever. There is no century like the next, there is hardly any decade like the next. Here's an idea, why not finance counter cyclical spending, if you really believe in that, through savings instead of debt? How about build up some kind of trust (foreign currencies, gold, whatever) during the good years then sell it to absorb losses from reduced tax revenue while maintaining services during the bad years. Why do we need debt?

Excellent post Nick. I think it's also worthwhile (but maybe too political) to point out the apparent bi-polar nature of the Opposition who back in December were slamming the Conservatives for not spending enough. Now they are apparently spending too much and that's a bad thing.

Mark Dowling: refer to the WCI post a few notches down regarding debt/GDP levels and reassess whether we weren't stocking the storehouse.

I think rating agencies will look at the strength of our resource-based corporations, sound financial system and responsible provincial governments and conclude the exact opposite of what you're implying.

The optimal debt/GDP ratio is not necessarily zero.

There is a natural demand for government debt, just as there is a natural demand for money.

Both can grow proportionately with GDP, without being a financial threat.

Mark Dowling: but interest payments owed on the debt are included in the newspaper definitions of deficits. I would just say that part of that interest reflects an inflation premium, and should be subtracted if we are interested in what happens to the real debt over time, as opposed to the nominal debt.

Yes, the future, and future politics, are uncertain. It might be worse, but it might be better. I have assumed it will stay the same as the past, on average.

pointbite: see above for the interest payments, and whether the future will be better or worse than the past. And as Mark says, the government has been saving, by reducing the debt/GDP ratio, as well as the absolute, nominal debt. How much saving is enough?

Mark: Thanks! I was wondering about saying something political, but I always get muddled about who said what when. But as far as my memory goes, it went something like this:
Conservatives: there will be no deficit.
Economists like me: Unless we are very lucky, or government policy is very foolish, there will be a deficit.
Liberals, Bloc, and NDP: we need a big deficit now!
Conservatives: there will be a deficit.
Liberals, Bloc, and NDP: There's gonna be a big deficit? That's terrible!

It's f'ing sad, it really is.

anon @ 10.55: I agree. But I wish I had a better theory (or actually, any half-decent theory at all), of what exactly it means to say there is a "natural demand" for government debt, what determines it, and what the optimal debt/GDP ratio is.

I did do a paper many years ago, with my Carleton colleague Vivek Dehejia, in which we sketched out a theory, based on a prudential theory of taxation. It was better than nothing, but I'm not sure we even convinced ourselves.

Anon, there is also natural demand for heroin, but nobody argues the government should supply it.

Also I just remembered, there has been an increasing trend in recent years (at least in the US, not sure about Canada) to finance the national debt with short term paper. That would strengthen the interest rates argument, because they now have an enormous amount of debt to rollover every year, so they are very susceptible to interest rate changes from year to year, a few bad years in a row and the government could go Argentinian on us, regardless of any future GDP we could theoretically "make up" in future years. The US government has an adjustable rate mortgage. And if/when that happens, please don't say nobody could have predicted it.

Nick, I don't consider reducing debt to be savings.

pointbite: doesn't The Economist want the government to supply heroin on demand (at a suitable price)? Or does it want to leave it to the private sector?

But heroin aside, if there's demand for a government product, that the government can produce and make a profit doing so, why shouldn't the government satisfy that demand? People want to hold some government debt even at very low interest rates, because they believe, not unreasonably, that it is safe and liquid. (One could make the same argument about money, though I'm not sure how much that is due to restrictions on private monies.)

Lots of short term debt, promising to pay in a currency you can't yourself print, is indeed very risky. There's always a danger of a run, so you can't roll over the debt. That's what happened in Argentina. That's what might happen in Eurozone countries. That's what does happen in commercial banks, until the central banks with their printing presses stepped in to cover them. I'm not sure how big a problem it is if the debt is denominated in your own currency. But in any case, that would be an argument against excessive short-term debt, not long.

Otherwise though, I agree that the shorter the average term to maturity on the national debt, the quicker changes in expected inflation will be reflected on interest rates on the national debt.

If you want government savings, and paying off the debt isn't enough, that means the government has to own private assets, the liabilities of firms and households, or real capital. That's something I would be a bit leery of, if it were too much, for too long. "You some kind of commie, wants the government to own the means of production?" ;)

Nick, the government could make a profit selling lots of things, like heroin, that doesn't mean society benefits or government is best suited for the job. If government refused to borrow, all that cash would become available to the private sector. We'll never know what we could have had instead of all this government debt (with little to show for it).

Your argument sounds like "I should because I can" which I have a tough time accepting. I can afford lots of things I don't buy, even though plenty of people are willing to lend me money to buy them. Similarily, rich countries can afford extravagent governments but that doesn't mean we're better off with them. I think this is perhaps a political question more than "just" an economic one, I'm not disagreeing that countries can survive with some level of debt for extended periods of times, perhaps even (gasp) forever, but we could also survive on a potato diet for a long time... I'm not interested in mere survival/maintenance/status quo, I want innovation, creativity, growth, inspiration... none of that comes from government, usually.

Paying off the debt is good, but it's not savings. I don't want the government to own anything, I'm not in favor of government trying to stabilize the economy with counter cyclical spending, but if people insist I would rather they fund it with accumulated foreign currencies, foreign government bonds, gold and stuff like that.

Nick, the government could make a profit selling lots of things, like heroin, that doesn't mean society benefits or government is best suited for the job. If government refused to borrow, all that cash would become available to the private sector. We'll never know what we could have had instead of all this government debt (with little to show for it).

Your argument sounds like "I should because I can" which I have a tough time accepting. I can afford lots of things I don't buy, even though plenty of people are willing to lend me money to buy them. Similarily, rich countries can afford extravagent governments but that doesn't mean we're better off with them. I think this is perhaps a political question more than "just" an economic one, I'm not disagreeing that countries can survive with some level of debt for extended periods of times, perhaps even (gasp) forever, but we could also survive on a potato diet for a long time... I'm not interested in mere survival/maintenance/status quo, I want innovation, creativity, growth, inspiration... none of that comes from government, usually.

Paying off the debt is good, but it's not savings. I don't want the government to own anything, I'm not in favor of government trying to stabilize the economy with counter cyclical spending, but if people insist I would rather they fund it with accumulated foreign currencies, foreign government bonds, gold and stuff like that.

I'd say long-term debt can be grown at a lesser rate equal to whole minus chemical company revenue/profit growth among other sector slices of the economy, not GDP growth at large. If banks post record profit it doesn't mean federal debt can be driven up, maybe just the opposite for the future outside Australia/Canada. Some pessimistic calculations say environmental externalities mean economy is really getting smaller (need surpluses under N.Rowe's model); probably safe to say 1/2 of China's growth shaved by these costs so real sustainable rate of debt is maybe 1/2 GDP growth rate.
It really depends whether or not you think the better investment is Iggy's High Speed Rail (Bombardier), Harper's Oil Sands, or a wild card for the next generation to choose (pay down debt with NDP tax rates and LSD taxes). Looming health care cost increases are going to drown whatever debt math voodoo you can come up with. The money Flaherty gave to oil sands and financials could've gone to set up a Trust for hospitals to purchase new Staph-fighting technologies regularly. Those Staph sensors and hand-wash beepers will be sacrificed for these too low tax rates. First Harper gives bad personal portfolio advice last fall, then Flaherty dooms the impoverished pensioners by impoverishing future hospitals and nursing homes. When all the provinces go broke at the same time with healthcare costs it will be analogous the systematic risk when all the dumb banks when belly-up that were supposed to insure risk. This is the time to build surpluses!!! Cons broke the piggy bank.

Phillip: I don't think that's fair. I'm certainly no fan of the Conservative party, but let's not forget that in Sept/Oct 2008 the world economy was clinically dead. If not for the Fed's actions this could easily be GD 2.0. The US banking system is huge mess, etc ... I can't imagine a plausible scenario under which Canada wasn't going to run big deficits for a long while. If anything, we should be thankful it isn't a lot worse.

Sadly, a $50 billion deficit really is a $50 billion deficit. Only by assuming that debt has no (net) cost could you really argue that there is no cost to constantly escalating debt to keep pace with GDP.

As always, the optimum amount of debt depends primarily on 2 things: 1) whether the borrowed funds generate a return sufficient to more than cover the interest and 2) concern for avoiding bankruptcy in the case of a change in circumstances. Maintaining debt as a static percentage of GDP arguably neutralizes any increase in the latter concern, but the former concern remains.

Government doesn't borrow to invest and make a return on investment - that's just not how it operates (to the extent that anything the government owns *does* operate this way, the usual practice is to carve it into a crown corporation in recognition of this distinction.)

So, much like consumers, governments generally impoverish themselves by borrowing more, even if they maintain a flat debt to income ratio over time.

The path of least resistance for a government running a budget deficit is to hold the line on spending, don't budge on tax rates from a static analysis point of view, and then let the economy simply grow. Eventually tax revenues will increase and therefore the deficit will eventually turn into surplus, assuming the economic expansion goes on long enough.

I'm not saying this is necessarily the best way to go about it economically, it isn't. The best path economically in my point of view, and in the view of a certain SG, is to cut or abolish taxes on corporations, and swap them with sales taxes, assuming one wants to keep spending level. The economy ought to grow faster that way, especially over time (not as much in the very short term). This is about as close to a free lunch as you can get.

Both ways though refute the line "If the government runs a deficit, it means you have to increase taxes or cut government spending sometime in the future, right?".

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