In a research note published Friday, Goldman Sachs economists asked a key question about the rising U.S. deficit — one that deficit doves have raised repeatedly: Why should we worry about deficits if Japan, which has a much higher debt-to-GDP ratio, hasn’t had a debt crisis?
“Japan’s experience confirms that a debt crisis is difficult to imagine in a country that issues debt in its own currency, has a flexible exchange rate, and controls its central bank,” Goldman economists David Mericle and Daan Struyven write.
Nevertheless, they say, debt dynamics can still have some dangerous economic consequences — and can lead policymakers to face a difficult choice between making necessary fiscal adjustments and allowing an economy to overheat.
The Goldman economists compared debt dynamics in the United States and Japan, focusing on the primary budget balance and the gap between interest rates on government debt and the GDP growth rate. They make a couple of points regarding U.S. debt:
First, the United States may have a lower debt-to-GDP ratio, but “its debt servicing costs are on a worse trajectory because of rising rates and a more negative primary balance.” The costs of servicing the U.S. debt, as a share of GDP, are already equal to Japan’s — and are heading higher — while Japan’s debt servicing costs are falling. “The possibility of a future trade-off between high debt servicing costs and overheating looks more salient in the US than in Japan, where overheating would be welcome following two decades of chronically low inflation.”
And second, even without a full-blown debt crisis, a large debt burden can be costly “if policymakers feel compelled to tighten at an inopportune time, as Japan experienced with its 1997 and 2014 consumption tax hikes.” U.S. deficits will have to shrink to get the debt under control, the Goldman economists say, but that could reduce the fiscal space lawmakers have — or at least the fiscal space they perceive they have — to respond to the next recession.
