There's never been a better time to be deep in debt.
A dearth of safe assets, low rates and central bank purchases are keeping bond yields low and are likely to continue doing so for years to come. But governments are missing out on this opportunity to finance investments, partly because of their focus on gross debt-to-GDP ratios.
A new risk-weighted measure of sovereign indebtedness developed by Oxford Economics shows that the burden may be less than governments realize and that there's plenty of space for more fiscal expansion.
The methodology, steered by Oxford Economics's head of macro research, Gabriel Sterne, and his colleague, Daghan Ozbilenler, relies on the fact that not all sovereign bondholders are equal: some, like foreign banks and hedge funds, are more likely to take flight when things turn sour and therefore riskier; others, such as domestic pension funds, actually want to avoid destabilizing government finances. At a time when central banks hold large amounts of state debt, this matters.
“Governments are too concerned about levels of their indebtedness, judging by their inadequate fiscal responses to insufficient demand, inequality and low funding costs,” the authors write. “Although markets may initially react to a major economy’s fiscal expansion by selling long-end government bonds, the subsequent lack of significant inflationary pressures or sustainability issues means that any sell-off would be relatively short-lived.”
Japan and Italy, with large debt burdens that are mostly held by domestic actors, are the countries that benefit the most from the calculation. But also austerity champions like Germany see a dramatic improvement in recent years, thanks in part to financial retrenchment behind national borders.
In fact, Oxford Economics's measure can put to rest concerns about the post-crisis expansion of government debt. The risk-weighted debt-to-GDP ratio has risen only 1 percentage point since 2011, compared to the almost 10 percentage points of the gross measure.
There are caveats, however. The main one is that when central banks will eventually start unwinding their balance sheets, the risk-weighted measure will become less favorable. But this is still a long way off everywhere, maybe with the partial exception of the U.S.