Who’s afraid of big bad debt?

Are you terrified of Australia’s ballooning debts and deficits? You can strike that off your list of fears.

There’s a lot worth worrying about amid a pandemic. But too many people are worrying a bit too much about the cost of protecting our livelihoods at the same time that we’re protecting our lives.

The dollars are admittedly jaw-dropping: the first Federal response cost $17 billion, the second round cost another $66 billion, and then the third rang the bell at $130 billion.

Does that mean we’ve just sentenced younger Australians to a lifetime of higher taxes and sub-standard services?

No, we haven’t. Although the dollars are unprecedented, what’s even more unprecedented are the interest rates we’ll be paying on this new debt.

Never in the two thousand years of recorded history of interest rates has it been cheaper for governments to borrow. Never. And markets aren’t fazed in the slightest: they reacted to the latest package by dropping the rate on 10-year Commonwealth borrowing substantially further.

Hang on – aren’t we spending heaps more than we did in the GFC? You bet we are. The current spend is comfortably more than twice as big as a share of national income than that of a decade ago. But we’re also paying interest rates that are just one fifth as high as they were back then, meaning that the interest burden this time is only about half of its GFC equivalent.

The ongoing annual interest bill for these new borrowings will be $1.6 billion. How could we pay for that?

  • To take a simple example, you could pay for that by raising the Medicare levy from today’s 2%. It would have to go all the way up … to 2.14%.
  • And the total tax take as a share of national income would lift by less than 0.1%. (Had this extra Medicare levy applied last year, then the Federal tax take would have been 23.47%, rather than 23.40%.)

That’s not nothing. You’d much prefer not to have to pay that much extra in interest every year. And there’s a chance that rates eventually go back up – though probably not for a long time. Yet these costs are far from scary.

Yet that’s just the interest cost. Don’t we need to pay back the extra $213 billion in borrowings?

We can if we like. But that’s not how we dealt with the war-time debts of the past. (And yes, this is war – hitting harder and faster than the wars of the past, with more lives at stake, and being fought in our own streets rather than thousands of miles away.)

Australia’s economy will grow again on the other side of this war. So, here’s a simple suggestion let’s just let our debts from this new war simply become a smaller share of our growing economy over time.

That’s what we did with the war-time debts of the past. And it’s probably the smart play this time too. Self-imposed flagellation rarely makes sense. The same policies that were sensible ahead of this crisis will remain just as sensible after it too. And the federal budget after this crisis will look a lot like the ones before it.

Consider the numbers. We’ll be borrowing about an extra 10% of national income. If we choose not to pay back a single cent of that, the growth in our economy over time will halve to about 5% of national income in 18 years, and then halve again to 2.5% in a further 18 years.

So, the costs of what we’re doing really are big. And important. But they shouldn’t scare you as much as they have.

What about the benefits we’ll get from all this spending?

It may be less costly than people are thinking, but that doesn’t guarantee that it’s worth it.

Yet the benefits are clearly considerable.

For example, the release of the third package – the $130 billion wage subsidy – led Westpac to revise its estimate of the peak unemployment rate in Australia from 17% down to 9%. Deloitte Access Economics’ matching numbers are smaller (our forecast changed from 12% unemployment to a peak of 8%).

Our numbers imply we just saved more than half a million jobs, while the Westpac numbers suggest it was over a million.

Take a brief moment to absorb those stunning numbers.

And that’s just the upfront benefit. Consider two others:

  • It will be easier to get momentum on the other side of this crisis if we prevent the economy’s engine going cold in the meantime. So not merely will unemployment go up less in the first place, it will also go down faster thereafter.
  • Most importantly, past experience tells us that those who don’t get a job back in the first two years after they lose their job in a recession rarely work ever again in the rest of their lives – with knock on costs in everything from mental health to domestic violence. So, some of the jobs saved now will be returning benefits for a generation.

That’s why studies by economists over the past decade have increasingly come to the view that fighting as hard as you can to stop unemployment rising in a recession is incredibly important.

This time really is different

One last thing. In every other recession you’ve lived through, the Reserve Bank helped ride to the rescue. Not this time. Although it will keep pedal to the metal for a long time yet, the Reserve is essentially already out of ammo. We have both high unemployment and near-zero interest rates, known as a ‘liquidity trap’ in nerd speak. That’s why Australia is especially reliant on governments going harder than ever before – because the payoff to their actions is larger than ever before.

There are lots of things to be scared of. The fight for our health is a long way from being won.

But don’t be scared of the debt – its costs aren’t that bad. And chances are that taking on this debt will be a great investment in Australian livelihoods.

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