Yellen’s call to ‘act big’ reflects long reflection on public debt

WASHINGTON (Reuters) – At the confirmation hearing by US Treasury Secretary-designate Janet Yellen on Tuesday, she nodded about the need to put federal debt on a “sustainable” path, at least to term.

His more detailed comments defending President Joe Biden’s $ 1.9 trillion spending plan for the coronavirus, however, reflected a constant shift in economists’ thinking about the mountains of public debt in the developed world that has been underway ever since. decade and which has its roots in the virtual collapse of the euro zone.

Forget the amount borrowed, Yellen, former Federal Reserve chairman, told members of the Senate Finance Committee. Instead, focus on the interest rate paid and the returns it will generate, an approach that argues that the country’s future economic potential can support more borrowing today and make the roughly $ 26.9 trillion. less formidable American loans.

“The interest burden on debt as a percentage of (gross domestic product) is not higher today than it was before the 2008 financial crisis, despite the fact that our debt has increased,” he said. Yellen said. “Avoiding doing what we need to do now to combat the pandemic and the economic damage it is causing would likely leave us in a worse situation … than taking the necessary action and doing it through deficit financing .

Federal government interest payments now stand at nearly $ 600 billion a year, but historically low global interest rates have kept them roughly stable as a proportion of the country’s economic output since the 1990s .

This fact will be at the center of the debate as Congress debates Biden’s spending plan, and in particular checks whether Republicans remain prepared to spend more to fight the pandemic now that they have lost control of the White House and Congress. for the benefit of the Democrats.

In addition to the more than $ 3.5 trillion borrowed largely to fund the coronavirus response last year, “when will we get to the point where it starts to crumble?” This is what really worries me and no one is really talking about it in either party, ”Senator John Thune, a Republican from South Dakota, said at the Yellen hearing.

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In fact, at least among Yellen’s economic peers, there has been a lot of talk about the issue since the financial crisis and recession of 2007-2009, and the unrest in the eurozone that followed.

When a group of small European countries, Greece in particular, struggled to repay debts in the wake of the global financial crisis, the response from the largest members of the eurozone and the International Monetary Fund has been to insist that these countries drastically reduce public spending. .

Instead of helping a recovery, this harsh dose of austerity helped push Greece into an even deeper hole, and in fact worsened its deficits.

In retrospect, the IMF said it was wrong. After extensive research, Olivier Blanchard, then the IMF’s chief economist, finally concluded that public spending can have disproportionate benefits, especially in times of crisis when aggregate demand for goods and services is weak – like this is currently the case.

Fast forward a few years. Previously unorthodox ideas, such as modern monetary theory, which see a broader and stabilizing role for public spending have started to gain more attention, and mainstream economists have begun to rethink their view of debt in more ways. fundamental.

Blanchard, for his part, began to argue that when interest rates are lower than the growth rate of an economy – the case in many developed countries – countries should not hold back from well-designed public investments. .

Republican economists like Michael Strain have argued that U.S. borrowing levels cannot be ignored forever, but are a longer-term concern that should not undermine any response to the crisis. Current Fed Chairman Jerome Powell, a deficit hawk when he worked on budget issues at a Washington think tank, said the same thing.

Democrats like Jason Furman, who chaired former President Barack Obama’s Council of Economic Advisers, widened the debate further to frame the argument made by Yellen on Tuesday – it’s the costs of borrowing, not the levels of borrowing. debt, that matter.

“There is no single metric that sums up our overall fiscal position, but I think it’s helpful to keep the interest burden in mind,” Yellen said. “What we are finding is that although the amount of debt to the economy increases, the interest burden has not increased.”