While looking for some current material on public debt for my intermediate macro students, I came across this article from the Economist. It highlights the important role that US government debt plays in the financial markets. As you might know, the short term debt securities act as a good collateral in financial transactions, safe haven for foreign countries US dollar reserves and hence are always in demand. A steady supply of such securities crowds out the need for other asset backed securities to act as collateral and hence may reduce systemic risk and other harmful effects of private money creation. This reminds me of this blog post by David Andolfatto a while ago. It comments on Ricardo Caballero’s paper on Macroeconomics of Asset Shortages where Ricardo proposes that the root cause for mortgage based currencies gaining demand was shortage of good assets to facilitate financial transactions.
The point I want to make here is this: usually, a rise in government spending is associated with the rise in public debt. However, while thinking about efficacy of public spending in the context of current stimulus debate, I haven’t seen this beneficial role of the public debt taken into account. If we do so, then the estimated government spending multipliers that are rarely greater than one, can be argued to be actually underestimating the total beneficial effect of government spending. The important question however is how to estimate these benefits. Looks like a good food for thought over the summer break!