According to recent research, the idea that debt government spending is “low financial costs” is not only misleading, but also hides the fact that there are real economic costs even when interest rates are very low.
“There is no free lunch for debt-funded government spending. Despite record low interest rates, the economy and Canadians are actually charged,” said the study’s co-author, Fraser Institute. Bev Dahlby, Senior Researcher, said: press release July 7.
“Financial costs of government spending due to debtIs a fiscal policy review based on supporting debt-funded spending for “very low interest rates on government debt over the last few decades.”
“With low interest rates on government debt over the last few decades, some key economists are questioning the wisdom of fiscal policy to limit the use of deficits to cover government spending,” he said. The book states.
“This position is based on a simple model of public debt dynamics, which stabilizes the ratio of government debt to GDP if the real interest rate r of public debt is lower than the economic growth rate g. Means that you can do it, even if the government has a primary deficit, that is, your current income is less than your current program spending. “
Studies show that, with this concept, some policy makers believe that tax revenues do not have to be equal to program spending if the real interest rate on government debt is lower than economic growth.
According to some econometric studies cited in the report, when the government builds up debt, real interest rates rise and economic growth slows.
“Recent research by E et al. (2022) When the government’s budget deficit-to-GDP ratio rose by 1 percentage point, we found that interest rates on government debt in nine EU countries rose by about 10 basis points between 2002 and 2020, “quoting the study. The author states. Posted on SSRN, Repository For preprints dedicated to the rapid dissemination of academic research.
The negative impact of public debt on growth has also been documented in several studies included in the report.
“Probably the most comprehensive of these studies Wu and Kumar (2015) We conclude that if the debt ratio of developed countries rises by 10 percentage points, the annual economic growth rate will fall by 0.15 percentage points, “the report said.
“The evidence is clear,” said Ergete Ferrede, co-author of the study and senior researcher at the Fraser Institute, that the idea of low financial costs for debt spending is “misunderstanding.”
“Given the significant increase in government debt due to the pandemic and rising interest rate environment, it would be wise for policymakers to rethink fiscal policy,” he said.
The authors emphasized that government borrowing could overwhelm and replace private sector investment, reduce economic productivity and ultimately reduce Canadian income.
In addition, as government debt increases, the value of the “r – g” gap increases as interest rates rise compared to lower economic growth.
“”[A] A 1 percent increase in the federal, state, quasi-state, and local government sector’s debt-to-GDP ratio is associated with a 6.7 basis point increase in Canada’s rg gap. “
According to the author, widening the “r-g” gap means that the government needs to resort to significant spending cuts or raise taxes to stabilize debt levels.
“These costs aren’t theoretical, as Canadians have already tolerated them in times like the late 1980s and early 1990s, so major fiscal reforms were needed,” said Dalhby. ..