What are the limits to government borrowing?

THE SCALEGDPGDPGDP of Joe Biden’s plans is hard to exaggerate. Where the American president’s former boss, Barack Obama, pivoted quickly to deficit-cutting after the trials of the global financial crisis, Mr Biden’s first budget, which he unveiled on May 28th, will borrow unapologetically. The plans assume that annual fiscal deficits will exceed 4% of through to the end of the decade; net public debt will rise to 117% of in 2030 from 110% today. The largesse raises two big questions. One is whether, coming on top of past stimulus packages, it will contribute to an overheating of America’s economy in the short term. The other important question is whether in the longer term America can prudently afford to loosen the purse-strings for a sustained period. As crisis has hit and interest rates have fallen, politicians have felt more able to run up debts than in the past. But the issue of whether and when limits to borrowing might apply still remains. Recent research casts light on these constraints.In a new working paper, Atif Mian of Princeton University, Ludwig Straub of Harvard University and Amir Sufi of the University of Chicago attempt to gauge governments’ room to run. Their analysis (which does not incorporate the effects of the pandemic) builds on recent work that estimates how the “convenience yield” on government bonds—or the amount by which a bond’s yield is reduced because of the safety and liquidity benefits it offers investors—varies with the size of the debt burden. Other things equal, the greater the volume of outstanding bonds, the higher the return investors demand. Work by Arvind Krishnamurthy of Stanford and Annette Vissing-Jorgensen of the University of California, Berkeley, suggests, for example, that a 10% increase in the ratio of debt to pushes government-bond yields up by 0.13-0.17 percentage points. (In practice, of course, other things are not always equal: the long-run effect of increased bond supply on safety and liquidity premia may be offset by other factors, such as a short-run surge in demand for safe assets prompted by financial instability, leading to falling bond yields amid rising debt loads.)