The options for reducing public debt-to-GDP ratios in advanced economies are becoming extremely limited. Governments “are going to have to live with high inherited debts” – this was Barry Eichengreen’s message, presented to Jackson Hole on Saturday.
In a way, Eichengreen’s paper seeks to normalise elevated debt-to-GDP ratios. But this idea carries its own risks if it means real yields keep rising. Recent history has shown that shocks to the global economy are becoming more frequent. This will accelerate with climate change. The public finances are more exposed than ever before. Attempts to keep debt-to-GDP ratios stable, therefore, are unlikely to succeed.
If Republicans and Democrats are committed to maintaining entitlements, and won’t touch defence either, then this leaves just non-defence discretionary spending. But slashing spending in this portion of the budget will not fundamentally alter the trajectory of the deficit.
The data for this fiscal year underline the point. Of the $536bn increase in outlays this fiscal year (vis-à-vis FY22, adjusted for timing shifts in outlays), $244bn is due to the largest mandatory spending programmes ($111bn for social security benefits, and $133bn for healthcare). Military spending added $45bn to total outlays and the Department of Veteran Affairs another $27bn. Net interest on the public debt has added an extra $146bn to the deficit this fiscal year.
