Theories of public debt. Ricardo's Theory of Public Debts on JSTOR 2023-01-04
Theories of public debt Rating:
Public debt refers to the debt that is owed by the government of a country to its creditors, who may be individuals, institutions, or other governments. Theories of public debt are varied and complex, and they can be grouped into several categories. Some of the main theories of public debt are discussed below.
The Ricardian Equivalence Theory: This theory, proposed by economist David Ricardo in the early 19th century, suggests that public debt does not matter because people recognize that they will have to pay it back through higher taxes in the future. Therefore, they save more in anticipation of these higher future taxes, offsetting the effect of the debt on the economy. According to this theory, the level of public debt does not affect economic growth or the level of private investment.
The Crowding Out Theory: According to this theory, when the government increases its borrowing, it competes with private borrowers for a limited pool of funds, leading to higher interest rates and reduced private investment. This reduction in private investment is known as "crowding out."
The Debt Overhang Theory: This theory suggests that high levels of public debt can lead to a vicious cycle of debt and low economic growth. When a country has high levels of public debt, it may struggle to pay its debts and may be forced to default or restructure them. This can lead to a loss of confidence in the government's ability to repay its debts, leading to higher interest rates and reduced access to credit. The resulting economic downturn can then lead to even higher levels of debt as the government struggles to stimulate the economy and fund social programs.
The Debt Sustainability Theory: This theory focuses on the ability of a country to meet its debt obligations over the long term. According to this theory, a country's debt is sustainable if it can generate enough economic growth to pay off its debts and maintain its debt-to-GDP ratio at a manageable level.
The Modern Monetary Theory (MMT): This theory suggests that governments that control their own currency can increase public spending and debt without negative consequences, as long as they do not create inflation. According to MMT, governments can finance their spending by issuing their own currency, rather than borrowing from external sources. This allows them to stimulate the economy and address social needs without the constraints of external debt.
Overall, the theories of public debt highlight the complex relationship between public debt, economic growth, and the ability of a government to meet its debt obligations. While some theories argue that public debt is a critical tool for economic growth and stability, others suggest that it can have negative consequences if not managed carefully.
Public Debt: My Dissent from “Keynesian” Theories
Classical economist believed in an economy with full employment and a perfect competition as well as morbidity of the production factors. The overall effect of GNP on capital accumulation is positive. To start with, high public debts decreases national income and savings. From the borrowing of the king representing the country in the thirteenth century to the current debt crises, public borrowing has served different purposes in this process. Most of the government debts belong to this category. In this extension of his argument the critic would, however, be committing a second, and related, methodological error which has led to much confusion in debt theory.
[PDF] Theory of Public Debt and Current Reflections
In this situation projects with quick return will be preferred to long term because there will be high uncertainty on government actions and its policies in meeting the debt obligations Servèn 1997. In: David Ricardo on Public Debt. Modern governments do not have large accumulated cash balances to overcome budgetary deficits. From the figure it is easily seen that when the expected payment of the debt increases proportionally less than the debt stock, the distortions are such that extra amounts of debt start decelerating the GDP growth rate. Hence a programme of expenditure financed by borrowing is likely to have a greater net expansionary effect upon the economy than a programme of the same magnitude financed by taxation.
Modern war is an expensive affair. Leta 2002 in his research on external debt and economic growth in Ethiopia pointed out that although the indebted poor countries have been able to pay i. Refunding means the repayment of a loan by taking fresh loans. External factors include oil shocks, deterioration in the terms of trade and rising foreign interest rates. Thus, the creditor country has provided advantages such as new foreign market, export growth, employment increase, and technology transfer. Long Term Cost of public debt There are various long-term costs of public debt in an economy.
Toward this end, the organization seeks to stimulate interest in and disseminate results of recent research in theory, policy making, business practices, and regulation. It is also immoral, since the loan would have come from funds mobilized from all classes of income earners in a society. A reasonable level of external debt actually has a positive impact on economic growth while excessive debt stock is destructive. On the other hand, public debt incurred to cover budgetary deficits on revenue account or for purposes which do not yield any direct income to the government is classified as unproductive debt. In absence of good institutions and governance the freed resources would not translate to productive investments.
The government in turn receives money for meeting its expenditure, but incurs a liability for the payment of interest and the repayment of principal in the future. This practice of revenue raising was not prevalent prior to the eighteenth century. It will generate inflationary situation in the economy. Also he further found that, the Dornbusch-Krugman proposition that external debt leads to economic slowdown is rejected. External debt has an increasing effect on national income when it is taken and vice versa has a decreasing effect on national income when it is paid. The main reason for creditor countries to accept debt postponement and refinancing credits is to enable them to accept some new commitments to the debtor country with these instruments. Amoating and Amoaku-Adu 1996 urged if a greater proportion of export revenue were used to service external debt, then little foreign exchange would be available for investment and growth.
The subject of public debt is very much in the news today. Debt Relief On reviewing a two decades of debt relief Easterly, W 2002 conducted a study aiming at answering the key question as to why did HIPCs became very indebted. For governments, borrowing is essentially an alternative means of raising revenue to cover expenditures. Or, if debt issue is employed to substitute for taxation, the effects of tax reduction must be separated from those of debt increase. Therefore, in order to adequately appreciate the problem of indebtedness, it is essential to relate the debt with its repayments of some income resources generated by the debtor out of which the repayments could be made. In addition to these expenditures, the state had to resort to borrowing due to major infrastructure investments, war, development financing, natural disasters, economic crisis, and budget deficits. If he had postulated, as a condition for analysis, that the alternative to debt issue is currency creation and that the period in which the choice among these two relevant alternatives is made is characterized by Keynesian-type unemployment, there would be no differential income effects other than those directly attributable to debt issue per se.
This chapter has provided a clear exemplification of the importance of debt sustainability, which is considered the way forward in enabling high debt-ridden nations to service public debt at a sustainable level. That is it can be freely bought and sold in the market. In adverse selection case, creditors give relief to countries which face payment difficulties and not the ones that are willing and able to increase their investment. On such occasions it may issue new securities and pay back the old debts, from the funds thus obtained. Consider two communities which are otherwise identical, but in the first of which there is no internal national debt, while in the second there is a national debt the interest on which is as great as the rest of the national income put together. Therefore, in modern days, the fund does not accumulate or continue from year to year as explained earlier. This situation has brought the new market, technology transfer, and economic power to the developed countries, while it has caused consumption society, external dependency, debt-interest spiral, and ultimately external debt crises in the developing countries.
This is the only permissible means of actually comparing what will happen with and without the debt. In Community II, individuals earn 100; they receive 100 in interest…. However, both the sudden fluctuation in capital movements and the implemented incentive mechanisms have dragged the developing countries to the external debt spiral. UK: Edward Elgar Publishing Limited; 2017. This phenomenon brings the important problems for developing countries.