It is no great shock that most experts surveyed in a new poll this week by Chicago Booth’s Initiative on Global Markets (IGM) agreed that countries with “high” debt loads “risk losing control of their own fiscal sustainability, through an adverse feedback loop in which doubts by lenders lead to higher government bond rates, which in turn make debt problems more severe.”
While virtually all economists—94 percent if weighed by the experts’ confidence in their answers—in the panel agreed, many suggested a pertinent and difficult issue is finding that threshold at which lenders feel that a country’s debt-to-GDP ratio is too “high,” and begin pushing it into a feedback loop of higher interest payments and larger budget deficits. “The only question is when the tipping point kicks in,” said Chicago Booth’s Anil Kashyap.
Fiscal tipping points may differ across countries. Emerging markets, for example, are said to suffer from “original sin,” or the inability to borrow in one’s own currency. These countries will arguably have a lower tipping point than countries such as the US and the UK, as some panelists pointed out.
Economists have also argued that countries that enter a monetary union, such as Eurozone countries, face a similar problem because they have no control over the currency in which their debt is issued. High debt loads do not automatically translate into high borrowing costs. “Right now the US can borrow easily with high debt, but some euro countries cannot,” noted Stanford University’s Jonathan Levin. The US 10-year bond rate in 2012 was less than 2 percent while that of Spain was close to 6 percent, even though Spain had a much lower debt-to-GDP ratio than the US in 2011.
Japan is another exception. Stanford’s Robert Hall noted that it’s interesting that Japan hasn’t yet approached the tipping point. Japan’s gross debt was 230 percent of GDP in 2011 but its 10-year borrowing rate was below 1 percent in 2012.
What’s unique about Japan is that the country currently has a very high savings rate and an extreme home bias—95 percent of Japanese sovereign debt is held domestically. But Japan may soon be forced to rely more on international investors, given that the country’s saving rate is likely to fall in the next decade with its aging population.
Japan’s experience, as well as the sovereign debt dynamics of 19 other advanced economies in the last 12 years, was recently analyzed in a research paper presented at the 2013 US Monetary Policy Forum, organized by the IGM (and summarized by our reporter here). In this paper, the authors used a statistical analysis that allows for differences between countries to find a debt threshold that could make these countries more vulnerable to reaching a tipping point.
As the authors summarized in a Wall Street Journal op-ed, “Countries with gross debt above 80 percent of GDP and persistent current-account deficits—as is currently the case in the United States—face sharply increasing risk of escalating interest payments on their debt. This means even higher budget deficits and debt levels and could lead to a fiscal crunch—a point where government bond rates shoot up and a funding crisis ensues.”