How Much Public Debt Is Too Little?

All too often, in governments, the left hand does not know what the right hand is doing. A decision taken by one ministry may not entirely take into account its repercussions on the other ministries.¹ The net result is policy dissonance, which, at best, dilutes policy synergy, and, at worst, can lead to systemic crisis. This paper examines a particular instance of the latter form of policy dissonance—the decision on the level and issuance of public debt. The irony is that the policies that can potentially be impacted by this decision are all, in one way or another, related to the government’s Ministry of Finance itself; or, to put it more bluntly, even the right hand does not seem to know what it is doing.

In an article in 2017, the author had examined the recommendations of the review committee on the Fiscal Responsibility and Budget Management (FRBM) Act² through the prism of the debate contained in the note of dissent by Arvind Subramanian,³ one of the members of the review committee, and the rejoinder of the committee to this note of dissent (Sen 2017). What was striking was that despite their differences on a number of important counts, both the protagonists had implicitly agreed that a secularly declining public debt to gross domestic product (GDP) ratio is unambiguously a good thing, and hence recommended fiscal rules that would lead to precisely such an outcome.⁴ Intuitively, this view is seriously problematic, despite the fact that it is entirely in consonance with the established view of the economics profession. Almost the entire literature on this subject treat public debt as an unavoidable evil—sometimes, but rarely, condescending to consider it a “necessary” evil.⁵ Virtually all the analytics, therefore, is on determining how much public debt is too much, beyond which it becomes a systemic threat to the economy.⁶ The discomfort with this perspective primarily stems from the fact that government debt is the only interest-yielding risk-free asset in any country,⁷ and is therefore central to a wide range of key economic variables and decisions in a modern economy. Unless these aspects are explicitly taken into account while assessing the “optimal” level of public debt, the analysis would be seriously flawed, and indeed perhaps dangerous.