Does the national debt matter?
13 Jul, 2025 at 17:00 | Posted in Economics | 1 Comment
Most people have a very personal view of the nature of debt. We know that high levels of debt and deficit spending at the household level are not sustainable. At some point, household debt has to be paid back. If a household is unable to do so, its debt will have to be renegotiated. It is natural to think that the same must hold true for governments. But this “government as a household” analogy is imperfect, at best. The analogy breaks down for several reasons.
While a household has a finite lifespan, a government has an indefinite planning horizon. So, while a household must eventually retire its debt, a government can, in principle, refinance (or roll over) its debt indefinitely.
Yes, debt has to be repaid when it comes due. But maturing debt can be replaced with newly issued debt. Rolling over the debt in this manner means that it need never be “paid back.” Indeed, it may even grow over time in line with the scale of the economy’s operations as measured by population or GDP.
Unlike personal debt, the national debt consists mainly of marketable securities issued by the U.S. Treasury … Today, U.S. Treasury securities exist primarily as electronic ledger entries. These securities are used extensively in financial markets as a form of wholesale money … If cash is needed to meet an obligation, the security can either be sold or used as collateral in a short-term loan called a “sale and repurchase agreement,” or repo, for short. Because investors value the liquidity of Treasury securities, they trade at a premium relative to other securities …
When the interest comes due, it can be paid in legal tender—that is, by printing additional U.S. or Federal Reserve Notes. It follows that a technical default can only occur if the government permits it. The situation here is similar to that of a corporation financing itself with debt convertible to equity at the issuer’s discretion. Involuntary default is essentially impossible.
Interestingly, Andalfatto — presently Senior Vice President in the Research Department at the Federal Reserve Bank of St. Louis — makes arguments that closely align with mine and those of other MMT economists. He points out that a government issuing debt in its own currency can always technically meet its obligations — by creating money to pay off that debt. And like MMT, Andolfatto also emphasises that the real constraint on government spending isn’t the debt level, but inflation.
Central to the Keynesian-influenced view on debt is the fundamental difference between private and public debt. Conflating the one with the other is an example of the atomistic fallacy, which is basically a variation on Keynes’ savings paradox. If an individual tries to save and cut down on debts, that may be fine and rational, but if everyone tries to do it, the result would be lower aggregate demand and increasing unemployment for the economy as a whole.
An individual always has to pay their debts. But a government can always pay back old debts with new ones, through the issue of new bonds. The state is not like an individual. Public debt is not like private debt. Government debt is essentially a debt to itself, its citizens. Interest paid on the debt is paid by the taxpayers, on the one hand, but on the other hand, interest on the bonds that finance the debts goes to those who lend out the money.
Abba Lerner’s essay Functional Finance and the Federal Debt set out guiding principles for governments to adopt in their efforts to use economic — especially fiscal — policies in trying to maintain full employment and prosperity in economies struggling with chronic problems with maintaining a high enough aggregate demand.
To Functional Finance the choices made by governments to finance the public deficits — and concomitant debts — are important, since bond-based financing is considered more expansionary than using taxes. According to Lerner, the purpose of public debt is to achieve a rate of interest that results in investments making full employment feasible. In the short run, this could result in deficits, but he firmly maintained that there was no reason to assume that the application of Functional Finance to maintain full employment implied that the government had to always borrow money and increase the public debt. An application of Functional Finance would have a tendency to balance the budget in the long run since basically the guarantee of permanent full employment will make private investment much more attractive, and a fortiori, the greater private investment will diminish the need for deficit spending.
To both Keynes and Lerner, it was evident that the state could promote full employment and a stable price level – and that it should use its powers to do so. If that meant that it had to take on a debt and (more or less temporarily) underbalance its budget – so let it be! Public debt is neither good nor bad. It is a means of achieving two overarching macroeconomic goals – full employment and price stability. What is sacred is not to have a balanced budget or run down public debt per se, regardless of the effects on the macroeconomic goals. If “sound finance”, austerity, and balanced budgets mean increased unemployment and destabilising prices, they have to be abandoned.
