Interest & Inflation: When is government debt a problem?

Whether or not debt is an issue depends on a number of things. There’s some rules of thumb about what ‘good’ and ‘bad’ debt look like, but the extent to which they apply depends hugely on the country and the power balance at hand. Very generally speaking, debt borrowed in a country’s own currency is seen as less dangerous than debt in someone else’s currency. If you’re in control of your own debt, you can print more money as a last resort, and there’s less chance of the debt being used as a political tool by the creditor country.

The interest rate is one of the most important things that determines whether debt is a big issue, or not. If the interest rate on debt is low, it’s not a huge issue: the money you’ll have to pay back in addition to what you borrowed isn’t much. When a currency is going through inflation, or its value its falling, then you might even gain from borrowing, because the currency you borrowed in is worth less than it was when you borrowed it, so your debt has, in a way, decreased. If it’s losing value at a faster rate than your interest rate—called a negative real interest rate, then that’s even better—you’re practically making money. But if the interest rate is high, you’ve got a problem.

The problem is the time frame in this cycle. Because we as individuals have such negative associations with being in debt and spending money we don’t have, it’s politically complicated for a government to keep up a high deficit without its citizens getting nervous. But a lot of economists think that growing public debt stabilises the economy. How? By allowing a government to take action to keep jobs and activity stable when private demand is declining.

Not all debt goes through these cycles, and it’s arguable whether they’re as ‘natural’ as some economists claim. In some countries, governments borrow money to sustain government spending even in the good years, in what are called structural deficits. These aren’t always considered a problem - a lot of economists think the debt-to-GDP ratio, or the comparison between how much debt a country in and how fast it is growing, is more important than absolute debt. So if the ratio isn’t too high, they’re not too worried.