A government that has its fiscal arithmetic wrong, heads for a packet of problems;nominal interest rates rise over fear of inflation, business moves wealth out fearing higher taxes, real interest rates rise and,and inflation shrinks division of lalabour;and hence, productivity. Can this scenario loom over economies with low interest rates , stock prices remaining buoyant, and inflation remaining subdued. After all, low interest rates put no downward pressure on public investment,low inflation keeps the extra debt that a government issues still prized as having value, and boosts economy by deleveraging and accelerating spending.Economists are not so sure.They now look at not only quantities – the amount of debt that a government has issued – but key indices.The prices of government debt reflect the rate of inflation ( as bonds are traded for commodities, cash, and stocks ) ;the nominal interest rate and the level of the stock market. If all three are in green, it means markets would prefer government debt to grow at a faster pace than current forecasts indicate.As a thumb rule, debt at 80-90% of GDP, crowds out conomic activity.Correlation between high debt and low growth must predicate whether the government debt itself is a risk. A study of economies a) where interest rates are higher and the stock market is lower, and a higher debt/GDP ratio ,does indeed mean slower growth ,b) where inflation rates and govt. debt are both high and c) where growth was already slow, and thus where high debt/GDP ratios show that the crux of the issue emanates from the denominator, not the numerator. It now appears that there is less risk to accumulating more government debt until interest and inflation rates begin to rise above normal levels, or the stock market plunges.But much larger benefits accrue from tackling inadequate infrastructure, administrative lag and capacity under - utilisation.This seems to be borne out in most world economies,today.
( PUBLISHED FIN CHRONICLE MAY 27 )
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