When used effectively, public debt can help a country’s standard of living. It enables the government to construct new roads and bridges, improve education and job training, and pay for retirement benefits. This encourages people to spend today rather than save for the future. This spending stimulates the economy even more.
Why is a country’s debt important?
One of the most critical public policy challenges is the national debt level. Debt can be utilized to promote a country’s long-term growth and prosperity when used properly. The national debt, on the other hand, must be assessed properly, such as by comparing the amount of interest expense paid to other governmental expenses or by comparing debt levels per capita.
How does debt impact a country?
Lower national savings and income are the four main outcomes. Higher interest payments will result in significant tax increases and budget cuts. Ability to respond to situations has deteriorated.
Is debt good or bad for a country?
Public debt is a useful approach for governments to gain extra capital to invest in their economic growth in the short term. Buying government bonds is a safe way for citizens in other countries to invest in the progress of another country.
This is a far more secure option than foreign direct investment. When persons from other nations buy at least a 10% stake in a country’s firms, businesses, or real estate, this is known as foreign direct investment (FDI).
Is it good to have debt?
Good debt has the ability to significantly boost your net worth or improve your life. Borrowing money to buy quickly depreciating assets or for the sole purpose of consuming is considered bad debt.
What is the impact of debt?
Most of us have experienced being behind on bills and worried about having enough money in our accounts to cover them all. We may also know folks who have succeeded in achieving their goals “I’m debt-free,” they say, and you wonder how they accomplished it. Is it realistic? It sounds amazing, but is it?
Before we look at how to get there, let’s look at how to get there “Let’s take a look at how debt affects our life now that we’re debt-free. Let’s take the case of John, who is heavily in debt. He’s maxed out his credit cards, has expenses to pay, and won’t be paid for another week. He lives paycheck to paycheck and believes he can pay his bills and buy a few groceries if he needs to live like a college student for a few days on Ramen noodles. John wakes up to a freezing house one day. His furnace has broken down, and he has to get it fixed. John doesn’t have an emergency savings, has maxed out his credit cards, and is unable to pay his payments or buy groceries. What exactly does he do? The logical reaction would be to apply for a new credit card. John is agitated at this moment. Hopelessness, melancholy, and terror have taken hold. How can he avoid getting into trouble like this again? John needs to figure out how to begin putting money down each month, regardless of the amount. When the unexpected occurs, having an emergency fund that is never accessed for normal expenditures helps relieve some of the stress.
Being in debt might make it difficult to achieve your objectives. When you’re living paycheck to paycheck, that vacation to see friends or the house you’ve always wanted to buy are simply out of reach. It’s time to take a look at your finances. On your way to work, do you stop for a specialty coffee every day? Do you go to the local sub shop every day for a sandwich? Do you and your pals meet together at a local restaurant on a regular basis to socialize? If you take a close look at where you spend money on a daily basis, there’s a good chance you might save $5-$10 every day, and those dollars add up. Do you have a credit card with a high interest rate? Look for a low-interest credit card and use it to consolidate all of your debt. Every year, this might amount to thousands of dollars. Make a point of cutting up your other credit cards as well. You don’t want to find yourself in a similar predicament. Keep your eyes on the prize, and you can achieve that long-term goal.
Debt can have a negative impact on your credit score. It’s a never-ending circle. A low credit score can be caused by excessive debt. You won’t be able to acquire a cheap interest rate on a loan if you have a bad credit score. Higher interest rates on loans have an influence on your available cash flow. Bad credit might make it difficult to get work or rent an apartment or house. When people are in debt, it’s typical for them to think it’s okay to skip a few payments. Paying late has a negative consequence, resulting in extra issues and debt.
Debt can also have an impact on your personal connections. It can lead to marital issues, conflicts with children, and the loss of friendships. When someone feels deprived, they may hunt for someone to blame. If your family is in debt, keep in mind that you are all in this together, and working together to discover ways to decrease non-essential expenditure and pay off debt is crucial. You could even turn it into a game and develop a way to award each other when cost-cutting suggestions are implemented.
What country has the most debt?
What countries have the world’s largest debt? The top 10 countries with the largest national debt are listed below:
With a population of 127,185,332, Japan holds the world’s biggest national debt, accounting for 234.18 percent of GDP, followed by Greece (181.78 percent). The national debt of Japan is presently $1,028 trillion ($9.087 trillion USD). After Japan’s stock market plummeted, the government bailed out banks and insurance businesses by providing low-interest loans. After a period of time, banking institutions had to be consolidated and nationalized, and other fiscal stimulus measures were implemented to help the faltering economy get back on track. Unfortunately, these initiatives resulted in a massive increase in Japan’s debt.
The national debt of China now stands at 54.44 percent of GDP, up from 41.54 percent in 2014. China’s national debt currently stands at more than 38 trillion yuan ($5 trillion USD). According to a 2015 assessment by the International Monetary Fund, China’s debt is comparatively modest, and many economists have rejected concerns about the debt’s size, both overall and in relation to China’s GDP. With a population of 1,415,045,928 people, China currently possesses the world’s greatest economy and population.
At 19.48 percent of GDP, Russia has one of the lowest debt ratios in the world. Russia is the world’s tenth least indebted country. The overall debt of Russia is currently about 14 billion y ($216 billion USD). The majority of Russia’s external debt is held by private companies.
The national debt of Canada is currently 83.81 percent of GDP. The national debt of Canada is presently over $1.2 trillion CAD ($925 billion USD). Following the 1990s, Canada’s debt decreased gradually until 2010, when it began to rise again.
Germany’s debt to GDP ratio is at 59.81 percent. The entire debt of Germany is estimated to be around 2.291 trillion ($2.527 trillion USD). Germany has the largest economy in Europe.
Why is debt bad for an economic environment?
We are now recuperating from a new recession, more than a decade after the global financial crisis, which has brought with it new questions and ramifications for the global economy. Never before has the world’s economy experienced such a sharp decline in activity. Much is yet unknown about how things will turn out. While the globe appears to be slowly regaining its footing, the speed with which it will do so has been highly discussed. The virus’s steady spread continues to be a source of concern.
The fiscal and monetary boost has been significant. Policymakers’ quick actions appear to have averted a worst-case situation. These acts, on the other hand, are likely to accelerate some long-term trends. These are some of them:
The three themes are intertwined in a variety of ways. The next article delves into each of these topics in depth.
Public debt
In what has been dubbed “the Great Accumulation,” public debt levels in affluent countries have been steadily rising for decades. Governments have run deficits for decades, allowing expenditure to outstrip receipts. Social program obligations have grown, and governments have been hesitant to turn off the faucets due to the precarious nature of their elected posts. Simultaneously, growth has slowed. This is due in part to an elderly population that prefers to save rather than consume (see next chart). While rises in the absolute level of debt are less troublesome, the debt-to-GDP ratio has been rising, implying that debt growth has outpaced economic development. Interest rates will rise as a result of this. It also lowers the quantity of money available for productive endeavors.
Debt-to-GDP ratios increased as populations aged
UN Dataset, IMF, RBC GAM are some of the sources. Based on 1990-2012 population statistics and debt ratios from 1990 to 2018.
Higher debt loads are a major source of concern since they can make economies less stable. Servicing expenses divert money away from investments that would otherwise be essential and/or productive for the economy. Infrastructure developments and technological investments are among them.
Higher debt loads might also limit a country’s ability to respond in the event of a catastrophe. Due to massive monetary stimulus, a structurally dropping level of interest rates, and increasing investor tolerance for large debt levels, this has not worked as a binding restraint in recent downturns. While debt-to-GDP ratios and service costs are currently reasonable, the possibility of higher risk premiums in the future remains if a country’s ability and/or willingness to pay that debt is called into question. In emerging market countries, where borrowing circumstances can be more diverse, there is a greater danger. Concerns, on the other hand, are not unimportant in other areas.
According to a large body of evidence, growing debt levels are harmful to economic growth. According to a well-known paper by Reinhart and Rogoff, a debt-to-GDP ratio of well than 90% is connected with a 1% drop in annual economic growth. 1 While the cause of this is debatable, it accounts for a significant share of annual GDP growth. Indeed, since the global financial crisis, when public debt levels skyrocketed, the speed limit for economic expansion has been lowered.
This is not a novel concept for investors. In the aftermath of the global financial crisis, countries battled with austerity measures to bring their public debt levels down to more reasonable levels. Not long ago, Greece had serious problems handling its bloated debt loads. As a result, the country was compelled to restructure its debts.
As the economy recovered and debt-to-GDP ratios stabilized, the headlines about governmental debt levels diminished to some extent over the last decade. It has, however, resurfaced as a hot topic. According to the International Monetary Fund (IMF), industrialized economies will have massive deficits of 11% on average in 2020. That’s not all, though. The median public debt load in developed markets might reach 122 percent of GDP. Meanwhile, as seen in the graph below, developing market debt levels are expected to reach historic highs by the end of the year.
Debt levels are surging around the world
Source: RBC GAM, IMF. Data is as of June 2020, and it is based on IMF projections for 2020 and 2021.
The current increase in public debt loads appears justified, whether or not it is sustainable. The economic downturn left a massive void. Policymakers’ initiatives therefore offered much-needed assistance to people and businesses. While the overall degree of fiscal stimulus has increased by an order of magnitude since the financial crisis, economic policy plays a completely different role when the government deliberately initiates a recession. The output loss associated with these containment measures is far bigger than the output loss associated with the global financial crisis. Indeed, it is comparable to the losses seen during the Great Depression.
The absence of central bank assistance in the 1930s may have exacerbated and prolonged the downturn. This time, the stimulus measures were aimed at preserving economic linkages, such as keeping people employed and firms solvent throughout the shutdown. This may have aided the economy’s recovery faster than it would have been otherwise. Continued efforts to halt the pandemic’s spread, on the other hand, are likely to delay recovery.
U.S. economic growth during recessions, past and present
As of July 31, 2020. RBC GAM estimates suggest a medium scenario. Haver Analytics, Macrobond, and RBC GAM are some of the sources.
This response’s scope and veracity are unquestionable. However, there are a number of unanswered uncertainties about how these deficits and high underlying debt levels will be dealt with. Consider the following scenario:
Debt sustainability may become a concern for governments with less sovereignty or credibility on the global stage. It may, in some situations, compel defaults. This is especially dangerous when currencies are not controlled by borders, or when large sums of debt are denominated in currencies other than the country’s own, as in the Eurozone. However, such a drastic consequence is improbable in industrialized countries, especially now that the Eurozone appears to be leaning toward a type of debt mutualization.
Developed markets have previously faced huge debt loads. The majority of these occurrences were followed by a period of consolidation and diminution. It was during World War II when today’s levels were last reached (WWII). Between 1946 and 1974, the debt-to-GDP ratio fell from 140 percent to 110 percent. 2 The difference between growth and interest rates accounted for three-quarters of the drop. In other words, countries that grew their economies faster than their debt payment expenses saw their debt-to-GDP ratio shrink by approximately 23%.
Governments can address large public debt loads in a variety of ways. Some of them have a wider acceptance than others. The most common ways include a combination of the following:
Simply growing the economy is a simple approach to lower the debt-to-GDP ratio. Because total debt levels remain constant as real economic growth accelerates, the debt load as a percentage of GDP decreases. Many say that this necessitates a healthy growth rate, which is difficult to achieve. However, the key factor is that growth outpaces interest rates. Any increase in GDP over the current rate of interest would reduce the overall debt-to-GDP ratio.
In this regard, governments can be patient if no more deficits are required. They can keep rolling over their debt and expect it to decline over time in relation to the size of the economy.
However, we are in a period of slower-than-normal growth. Each additional 1% of economic growth equates to a 1.4 percent reduction in the debt-to-GDP ratio, implying that bringing debt ratios below 90% could take decades. Future recessions and crises are also a factor to consider; on average, they occur about every ten years and could stifle this trend. As a result, countries may turn to additional measures in order to lower total debt levels faster than growth alone.
Governments can also run a primary budget surplus to try to minimize the overall size of their debt. Governments either increase revenue through tax increases or reduce spending through cuts to achieve this. The increased revenue generated from non-interest payments is then used to pay down debt. This creates a positive feedback loop, lowering both the amount of interest owed and the overall debt-to-GDP ratio. This approach of debt reduction is preferred by policymakers. Following the recent crisis, it’s likely that some may investigate this.
Many wealthy countries, on the other hand, have structural deficits. There appears to be less desire for the austerity measures that have typically been required to reduce structural deficits. Furthermore, variables such as commodity price volatility might make it difficult for governments to maintain a surplus. This is especially true if they rely substantially on export income (like Canada) or imports, where a sudden price increase could be disastrous.
Increasing taxes is one strategy to try to run a primary budget surplus. Consider the following scenario:
- enacting a wealth tax with the explicit goal of decreasing inequality while funding government spending Indeed, the United Kingdom adopted this strategy to pay for the costs of war during World War I.
Taxation, on the other hand, has its own set of problems. Increasing taxes appears to have a direct impact on government spending. Despite the fact that government revenues are rising, overall growth is projected to slow. Furthermore, tax increases are difficult to implement. Short-term remedies are preferred by elected leaders, and raising tax rates is political suicide to some extent. The discomfort is sometimes severe at first, but the benefits do not appear for years. For elected politicians whose terms are generally measured in years rather than decades, this can be an unsettling situation.
In the end, tax hikes are a matter of political will. They could be implemented by nearly any country if enough pressure was applied.
When inflation rises, nominal GDP rises as well, although overall debt levels remain same. The debt-to-GDP ratio falls as a result. The urge to inflate debt away is quite real. Given the extent to which central banks’ balance sheets have increased as a result of quantitative easing operations, it’s even more important now. However, as explained later in this article, above-target inflation is not a requirement for economic recovery, and it may be more difficult to obtain than first looks.
The problem with utilizing inflation to lower overall debt is that it stifles economic growth. Each 2% increase in the inflation rate is thought to equate to a 0.33 percent reduction in real economic growth. This is due in part to the effect it has on expectations, as rising inflation causes lenders to demand higher interest rates in order to avoid losing purchasing power. Borrowing becomes equally as expensive if not more so than it was before inflation took effect.
In general, inflation works best in lowering debt levels when it is unexpected and only lasts a short time. A tiny amount of inflation say 2.25 percent instead of 2 percent could be a feasible approach to help eat away at debt levels without causing financial market turmoil. Indeed, it’s feasible that future inflation levels will be modestly higher.
- Default: This refers to a decision or inability to repay debt, whether through debt restructuring (extending the term) or debt reduction (lowering the amount owed to creditors). Defaults are a common occurrence. Greece is a recent example from the European sovereign debt crisis. Outside of emerging market countries, however, it is extremely rare due to the detrimental impact on capital markets and related risk premia. In countries where domestic banks are the primary lenders and debt is kept in the local currency, restructuring is also problematic. In other words, insular economies would suffer as a result of their own conduct.
- Privatization of government assets: The ability of a country to privatize specific assets is frequently overlooked. Many governments own a variety of assets that, if necessary, may be extremely profitable and successful in reducing debt loads. Mineral rights, oil and gas reserves, structures, and critical gold reserves are among these assets. A country like the United States, for example, has roughly $1 trillion in outstanding student loans. Of course, not everything can be recovered. It’s also not a cure-all. However, it is an asset that might be sold while also meeting part of the need for income-producing assets.
- Financial repression: Following WWII, countries used financial repression as a means of reducing debt levels. How? Interest rates were artificially lowered by countries. In other situations, banks and other financial institutions were also forced to carry a certain amount of government debt. This was accomplished by using the following methods:
In addition, capital controls were in effect. This allowed inflation to increase at a faster rate without causing a capital flight. During this time, central bank asset holdings were similarly high. In certain senses, inflation facilitation could be seen as a monetization of budgetary shortfalls.
Some argue that today’s low interest rates, as well as the extent to which central banks are involved in the inner workings of financial markets, constitute a sort of financial repression. Aside from that, it’s unlikely that financial repression will take a more overt form, given that:
- A further hint of financial repression could result in a capital flight.
Furthermore, negative externalities would almost certainly continue. If lenders doubted their capacity to produce normalized returns, debt, for example, would require a larger risk premium.
We understand that reducing debt loads is vital to encouraging future investment on profitable assets. However, with rates as low as they are, some say that now is not the time to reduce debt, especially given the current weak growth. Policymakers lack the incentive to handle today’s greater debt levels without a signal or push from the bond market for increased risk premiums. Given that recessions and crises occur on average every ten years, debt loads may be forced higher.
Instead of reducing debt levels, governments may target stabilizing deficit expenditure. These efforts should be aided by modest economic growth and rates that are anticipated to remain low for a lengthy period of time. Of course, inflation may be allowed to run slightly higher for a short period of time.
Because the US dollar is utilized as the world’s reserve currency, the US is in a strong position. As a result, there is an inbuilt desire for the country’s paper. As a result, the United States may be less willing to confront its structural imbalance. This position, however, is becoming more precarious as the world grows more multipolar. At this point, it’s difficult to envision the United States mustering the political will to take any significant steps to reduce their debt levels.
Europe has long struggled with challenges relating to the Eurozone’s underlying countries.
This includes their ability and desire to increase debt levels beyond the Maastricht Treaty’s limits. Recent steps toward some type of debt mutualization may help to further unite the countries by tying them together not just through monetary policy but also through fiscal policy.
Emerging market countries, on the other hand, have a unique difficulty. Many of them are based on the pricing of raw materials. A tumultuous oil market could add to the burden. Many of these countries have a significantly higher chance of default. Given their small size in the grand scheme of things, it’s unlikely to be a systematic problem.
A bigger debt burden has more serious long-term repercussions. Higher debt levels hamper economic growth, according to research. At the same time, aging demographics may result in greater government entitlement costs. As a result, the amount of money available to reduce debt burdens and encourage productive growth will continue to be limited. For many countries, stabilization may be the best they can hope for.
While not a pressing issue at the moment, high levels of public debt and continued entitlement growth are expected to collide in the near future. They may continue to be a drag on future growth for a long time.
Who does the US owe the most money to?
Japan had $1.3 trillion in US Treasury bonds in July 2021, making it the largest foreign holder of the national debt. China is the second-largest holder, with $1.1 trillion in US debt. Both Japan and China want the dollar to remain higher in value than their respective currencies. This keeps their exports to the United States affordable, allowing their economies to thrive.
Despite China’s vows to sell its holdings on occasion, both countries are content to be the largest foreign holders of US debt. When China increased its holdings to $699 billion in 2006, it surpassed the United Kingdom as the second-largest foreign holder.
What does good debt mean?
You may have heard that debt is divided into two categories: good debt and bad debt. Money due for things that can assist develop wealth or boost income over time, such as education loans, mortgages, or a company loan, is referred to as “good” debt. Credit cards and other consumer debt are examples of “bad” debt because they don’t help you improve your financial situation. These are exaggerated statements. The differences between “good” and “bad” debt are far more subtle.
It’s worth revisiting this topic and learning the new debt game rules. While student loans and mortgages can help you develop wealth and enhance your income, it isn’t always or even always the case. A number of elements play a role in successfully utilizing “good” debt.
How much debt is healthy?
You want your debt to be as minimal as possible so that you may be financially flexible in the event of an emergency as well as for your long-term goals. You’ve probably reached your debt limit if you’re having trouble making monthly payments. How much debt is excessive? Keep your debt-to-income ratio below 43%, according to the Consumer Financial Protection Bureau. People with debts of more than 43% have a hard time paying their monthly payments, according to statistics.
How much debt is OK?
Lenders employ a uniform method to evaluate when debt becomes an issue, regardless of whether you make $1,000 per week or $1,000 per hour. It’s known as the debt-to-income ratio (DTI), and the formula is straightforward: recurring monthly debt minus gross monthly income equals debt-to-income ratio. It’s expressed as a percentage, and in general, you want it to be less than 35 percent.
Your regular monthly debt includes things like your mortgage (or rent), car payment, credit cards, student loans, and any other payments that are due on a monthly basis.
Your gross monthly income is the amount you earn before taxes, insurance, Social Security, and other deductions are deducted from your paycheck.
Assume you pay $1,000 per month on your mortgage, $500 per month on your auto loan, $1,000 per month on credit cards, and $500 per month on school loans. So your total monthly recurring debt is $3,000?
The immediate inference is that you drive a great car, but that is irrelevant to our conversation. What matters is your gross monthly revenue of $6,000 per month. Let’s get down to business.
Recurring debt ($3,000) divided by gross monthly income ($6,000) equals 0.50, or 50%, which is not a favorable ratio.
You’ll have a hard time securing a mortgage if your DTI is higher than 43%. A DTI of 36 percent is considered acceptable by most lenders, but they want to lend you money, so they’re willing to make an exception.
A DTI of more than 35 percent, according to many financial gurus, indicates that you have too much debt. Others push the limits to the 36 percent-49 percent range. The truth is that, while DTI is a useful measure, there is no single indicator that debt would lead to financial ruin.
Use our Do I Have Too Much Debt Calculator to see what percentage of your monthly income goes to credit card debt and mortgage payments, as well as how much money is left over to pay your other expenses.
