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People sometimes send me questions about gov’t debt - do we need to worry about it if we “never pay it back” and “interest rates are really low”. This is something we used to discuss every year in my undergrad public finance course, so perhaps a refresher would be helpful. 1/n
First, all government debt does get ‘paid back’ when it matures (unless it is a ‘perpetual bond’). When bonds mature, the gov’t typically sells new bonds to generate funds to repay the principal of the maturing bond. Interest on the new bond my be higher or lower. 2/n
So rather than saying ‘we never pay it back’ it is probably better to say ‘we never pay it off’ since we are paying interest to investors all time that government bonds are outstanding. 3/n
It is true that countries carry debts over many years and there always seem to taxpayers around to bear the interest costs - but the benefits of borrowing may be short lived. Future taxpayers may share the costs but not the benefits of borrowing. 4/n
What about the cost of paying interest? If real interest rates are just 1%, it takes 70 yrs for the real value of interest payments to equal the principal of the bond. If real rates are 2%, interest equals principal in 35 yrs. If real rates are 3% it takes only 25 yrs. 5/n
Right now, interest rates on gov’t bonds are really low. However, no one knows if we will be able to finance the giant deficits we are seeing at these low rates. Right now, the Bank of Canada, not private investors, is buying the bulk of federal and provincial gov't debt. 6/n
Normally, about one-third of federal debt is held by foreigners. Again, no one knows if they will buy the same share of our new debt when all other countries are running big deficits and borrowing at the same time. 7/n
This is not to say gov’ts should not increase spending and run big deficits now. It does mean that growing deficits and debt are a worrisome side-effect of the virus. We need to spend responsibly, because its likely our children will bear cost of debt we incur today. n/n
