UK, US Sovereign Debt Downgrade Fears not Credible
Worries increase over potential sovereign debt downgrades in the United Kingdom and even the United States are not credible, according to Oxford Analytica. Even worse, the fears themselves could slow economic recovery, OxAn says in Downgrade threats are not credible.
As government debt-to-GDP ratios in advanced economies are set to increase substantially as a result of stimulus spending and reduced tax receipts, credit-rating downgrades are being threatened.
Yet such threats are derived from overly simplistic and orthodox logic, and risk stimulating premature policy tightening, thus destabilising recovery.
Average deficits of 3% of GDP or less, and debt below 60% of GDP, are reasonable, though simplistic, guidelines for mature economies in normal circumstances. However, they are inadequate for treating extreme and unusual situations:
- • In a failing or volatile state, the prudent level for debt may be much lower if this can only be funded with short-term debt, and/or the country’s risk premium is high (eg due to other economic risks or political instability).
- • In contrast, in a very stable economy with high, conservative savings, a much higher supply of government debt may be tolerable, as seen in Japan, where debt of 170% of GDP coexists with bond yields of 1-2% and low inflation.
“There is no simple or precise yardstick by which these variables can be judged. The truthful, but unpopular, answer to the question of whether or not a particular debt level is “risky” is based on the contingency of context. ”
Another way of looking at this problem is to ask what effect higher deficits and debt levels may have on the economy concerned — what matters is the effect of these intermediate variables on the final targets of policy (such as sustainable improvements in welfare and living standards for the whole population):
- • It is sensible to ask a series of questions such as whether deficit spending might overheat the economy and feed inflation; whether high debt ratios will push up real interest rates and crowd out private spending, or simply and safely take up the economy’s slack; and what, if any, policies the government might propose to reduce debt, should this be necessary (ie the ‘exit strategy’).
- • If the answers to these questions suggest that there are few risks attached to raising debt (now and in the future), then whether government debt is 50% or 150% of GDP, it would seem to pose no discernable threat to the economy.
In effect, this has been the Japanese position — although economic orthodoxy might prevent it being acknowledged. Japan is among the countries with highest government debt, but it has not become a high-inflation, weak-currency country, and has few other characteristics in common with these other debtors.
It is important that rating agencies and markets not overreact to the sharp rise in government deficits and debt. After such a serious recession, it is crucial to ensure that the global economy recovers before starting to review — very carefully, on a country-by-country basis — the appropriate scale of public sector involvement in the economy, deficit spending rates and level of government debt.
This would imply a need for more informed debate on these issues to prevent impulsive reactions from credit analysts or governments too anxious to reverse the current expansion in debt too rapidly. After extraordinary efforts to avoid an even deeper recession in the global economy, governments will seek to retrench. However, such exit strategies will need to be phased extremely carefully to avoid destabilising a fragile recovery.
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