How Gerard Minack learned to stop worrying and love the debt bomb

After my piece yesterday, Gerard kindly sent through this analysis for readers:

Unprecedented peace-time budget deficits are pushing public sector debt to post-war record levels. Welcome to the newest normal. With fiscal taking over cycle management deficits are here to stay. This won’t worry me. Yields should remain low in a world of excess private sector saving and, increasingly, central bank deficit financing. And history suggests high public sector debt has little or no adverse effect on trend economic growth. Huge budget deficits will be the 2020 norm. The IMF expects the deficits will peak in this recession year (Exhibit 1). As an aside, the superb timing of these deficits reflects one of the many unique features of this cycle: policy makers could see the recession coming – because they caused it. Fiscal policy has almost always lagged in prior cycles, with deficits peaking after recessions have ended.

I expect that the Covid-19 crisis will shift the prime responsibility for macro cycle management from monetary policy to fiscal policy. The key test of this shift is not the willingness to run large deficits in a recession; the key test will be the willingness to run large deficits in the recovery. That was not the case after the GFC – fiscal policy was quickly tightened almost everywhere – but I expect that fiscal policy will be kept looser in this cycle. That in turn means that public sector debt levels – already at multidecade highs (Exhibit 2) – will keep rising.