It would be Wise for Heavily Indebted Governments to Reduce their Debts as soon as They can

Marti Subrahmanyam
By Patrick Augustin, Valeri Sokolovski, Marti Subrahmanyam and Davide Tomio
Over the past decade, economists like 2008 Nobel laureate Paul Krugman have urged states to further increase public borrowing. But too much debt can become a real problem. Indeed, it seems, especially in times of crisis, that nations with overly stretched budgets are more likely to be penalized by financial markets and incur higher borrowing costs. And this of course has important consequences for fiscal policy.

We studied thirty developed countries in America, Europe and the Asia-Pacific region, as well as 23 states in the United States, to measure the direct effect of the spread of the Covid-19 pandemic on borrowing costs governments (“  In Sickness and in Debt: The COVID-19 Impact on Sovereign Credit Risk” , January 18, 2021, discussion paper, unpublished).

We used data from the credit default swaps (CDS) market to learn about changes in the cost of borrowing for each state: CDS premiums frequently rise and fall as investors change positions. opinion on the perceived risks of loans to certain states. The study ran from 1 st  January 2020, when the World Health Organization (WHO) has set up its emergency action framework, to 18 May 2020 when stimulus funds from the European Union (EU) 500 billion euros has been proposed.

Read the full Le Monde article.

Marti Subrahmanyam is the Charles E. Merrill Professor of Finance, Economics and International Business