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The political economy of public debt three centuries of theory and evidence

The Political Economy of Public Debt

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The Political Economy of Public Debt
Three Centuries of Theory and Evidence
Richard M. Salsman

The Political Economy
of Public Debt
Three Centuries of Theory and Evidence

Richard M. Salsman
Assistant Professor, Program in Philosophy, Politics &
Economics, Department of Political Science, Duke University,


Cheltenham, UK • Northampton, MA, USA

© Richard M. Salsman 2017
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List of figuresvi
List of tablesvii
1 A brief history of public debt
2 Classical theories of public debt
3 Keynesian theories of public debt
4 Public choice and public debt
5 The limits of public debt


1.1Public debt of the United Kingdom as a percentage of GDP,
1.2Public interest expense of the United Kingdom as a percentage
of GDP, 1700–2015
1.3Public spending of the United Kingdom as a percentage of
GDP, 1700–2015
1.4Public debt of the United States as a percentage of GDP,
1.5Public interest expense of the United States as a percentage of
GDP, 1800–2015
1.6Public spending of the United States as a percentage of GDP,
1.7Public debt of 22 OECD nations as a percentage of GDP,
1.8Three projections of the US debt/GDP ratio (leverage),


1.1Gross public debt as a percentage of GDP, 15 OECD nations,
1.2Public spending as a percentage of GDP, 15 OECD nations,
1.3The paradox of profligacy: higher public debt leverage, yet
lower borrowing rates, G-­7 nations, 1980–2015
A.1Public debt theorists classified as realists, pessimists, and


The author acknowledges Michael Munger for being an invaluable mentor
and the model of a collegial, productive scholar, the late John David Lewis
for blazing a path I’ve since happily traversed, and Lisa Lynn Principe for
her loving and loyal support. My sincerest appreciation extends also to
John Allison, Carl Barney, and Yaron Brook for their invaluable support
of me professionally. Additionally, I am very grateful to Geoffrey Brennan,
William Keech, John Aldrich, Thomas Spragens, Richard Wagner, Peter
Boettke, and Richard Sylla for their valuable input and counsel on this
project. Finally, I thank Alan Sturmer, Karissa Venne, and Sarah Brown at
Edward Elgar Publishing for their terrific skill and utmost professionalism.
I’m proud of what I’ve accomplished here, yet I’m also solely responsible
for any errors or oddities that might still remain.


This work examines three centuries of the most prominent political-­
economic theories of public debt, to help illuminate various causes and
consequences of the unprecedented expansion of such debt over the
past decade and – as is probable – for decades to come. I consult and
­interrogate not only specialists in public debt but also the most influential
minds of political economy in modern history, from Hume and Smith in
the ­eighteenth century to Ricardo and Marx in the nineteenth century, to
Keynes and Buchanan in the twentieth century.
That public debt has undergone “unprecedented expansion” of late
reflects two facts. First, until recently, public debts were typically incurred
during wartime, not in peacetime. Second, unlike today, large debt
burdens in the past were usually felt most by less developed nations,
not advanced or industrialized nations. Evidence is abundant that these
new patterns are attributable largely to the spread of ever-­more democratic, fiscally profligate welfare states that expand social insurance and
pension schemes without overtaxing voting majorities,1 and also to
state ­guarantees of fragile financial sectors,2 which promote excessive
­risk-­taking (“moral hazard”) while necessitating periodic public absorptions of defaulted private debts.3 Equally unprecedented (and reckless)
is the recent adoption of zero or negative interest rate policies by major
central banks, which help highly leveraged sovereigns borrow at ­artificially
low rates, and enable still more public borrowing and ever-­rising rates of
public leverage.
The great American statesman and finance minister Alexander Hamilton
(1795) was the first to identify the relationship between unrestrained
democracy (with purely “popular” instead of constitutional government)
and unmitigated growth in public debt:
[There is a] danger to every Government from the progressive accumulation of
Debt. A tendency to it is perhaps the natural disease of all Governments and
it is not easy to conceive anything more likely than this to lead to great and
convulsive revolutions of Empire. . . There is a general propensity in those who
administer the affairs of a government, founded in the Constitution of man, to
shift off the burden from the present to a future day; a propensity which may be
expected to be strong in proportion as the form of the State is popular.


The political economy of public debt

Four decades later, writing in Democracy in America, Alexis de
Tocqueville (1835, p. 196) noted that when “the people is invested with the
supreme authority, the perpetual sense of their own miseries impels the
rulers of society to seek for perpetual ameliorations,” and “those changes
which are accompanied with considerable expense are more especially
advocated, since the object is to render the condition of the poor more
tolerable, who cannot pay for themselves.” Moreover, “democratic communities are agitated by an ill-­defined excitement and by a kind of feverish
impatience, that engender a multitude of innovations, almost all of which
are attended with expense.” The populace soon “discovers a multitude
of wants to which it had not before been subject, and to satisfy these exigencies recourse must be had to the coffers of the State.” Ultimately, for
Tocqueville, the cause “which frequently renders a democratic government
dearer than any other is, that a democracy does not always succeed in
moderating its expenditure, because it does not understand the art of being
economical. As the designs which it entertains are frequently changed, and
the agents of those designs are still more frequently removed, its undertakings are often ill conducted or left unfinished” such that “the State spends
sums out of all proportion to the end which it proposes to accomplish,”
even as “the expense itself is unprofitable” (pp. 196–7).
Hamilton and Tocqueville, being equally suspicious of unrestrained
democracy, were also prescient about its deleterious fiscal effects. It’s become a
commonplace in modern (unrestrained) democracies in the past century that
governments have extracted and spent ever-­higher shares of private income,
and while some political parties secure votes by promising higher public
spending without more taxing, others secure votes by promising lower taxing
without less spending. The result: an inherent bias in favor of chronic deficit
spending and public debt accumulation. According to Gersbach (2014):
Limiting the accumulation of public debt in democracies has always been
a problem but it has become a particularly pressing one in the last few
decades. . . [Democratic] political processes tend to push public debt to levels
that are likely to be socially undesirable. The reasons for this tendency are well
known and well explored: fragmented governments, political uncertainty, time-­
inconsistent public debt policies, rent-­seeking and increasing the advantages of
­incumbency – to say nothing of shifting the burden of public debt onto future
generations – can all lead to excessive debt accumulation.

The past two decades entail an astonishing reversal of fortune in
the public debts of democracies. When this century began, most major
nations, including the United States, were enjoying consecutive years of
budget surpluses, debating about the likely duration of surpluses, and
about how much public debts might decline without harm to policymaking


or markets. In 2000 the US Treasury submitted a draft chapter for the
Economic Report of the President, which analyzed the presumed dilemma
of a pending disappearance of US public debt; it was discarded when
­surpluses began to vanish.4
Today, opposite concerns prevail. The United States and major nations
now run record budget deficits, and are likely to do so for decades to come,
amid rising public leverage ratios that now approach levels last seen in
World War II. Major central banks now monetize vast sums of public debt
and vow to keep short-­term interest rates near zero indefinitely. Previously
unquestioned sovereign debtors, the United States included, have lost their
top debt ratings. The (seeming) paradox is that as public leverage ratios
have climbed in recent decades, public bonds yields have plunged, explicable partly by the resumption of the autocratic wartime policy of “financial
repression.”5 Central bank “independence” from politics, once seen as
crucial to monetary integrity, has given way to the phenomenon of “fiscal
dominance” of central banks by highly leveraged sovereigns.6 Record
low public debt yields imply that sophisticated bondholders reject debt
pessimists’ fears of a looming financial disaster and inevitable economic
collapse; meanwhile, the debt optimists, who insist that deficit spending “stimulates” economies, can’t explain why those receiving the most
­stimulus (Japan, United States) suffer persistent economic stagnation.
There’s no better time than now to re-­examine public debt history, theory,
and practice. The main purpose of this work is to convey and critique the
rich history of political-­economic theorizing on public debt across three
distinct schools of thought: classical, Keynesian, and public choice. Each
school seeks to explain the evolution of public debt, its political-­economic
causes and effects, the meaning of sustainability in debt burdens, and the
conditions under which governments are likely to monetize or repudiate
their debts. For empirical context, I begin with three centuries of data on
public debt for major nations, relative to national income, and government bond yield data for more recent decades. Throughout, I also examine
various methods for assessing fiscal capacity, debt sustainability, and the
outer limits of government borrowing. The empirics provide a concrete
basis for assessing the validity of public debt theories.
Clarity of exposition is enhanced, I believe, by a tripartite classification of the major theorists of public debt since the early 1700s. Beyond
the usual “schools” of thought on public debt, I classify debt theorists
as pessimists, optimists, and realists. For reader convenience I provide an
Appendix, which aptly groups the major thinkers.
Public debt pessimists typically argue that government provides no truly
productive services; that taxing and public borrowing detract from the
private economy, while unfairly burdening future generations; that high


The political economy of public debt

and rising public leverage ratios are unsustainable and will likely bring
national insolvency and perpetual economic stagnation. When public
debts become excessive or unpayable, pessimists advise explicit default
or repudiation. They also tend to view financiers in general and public
bondholders in particular as unproductive. Pessimists also usually endorse
smaller-­sized governments and free markets. With few exceptions, most
public debt pessimists appear in the classical or public choice schools
of thought; the most representative are David Hume, Adam Smith, and
James Buchanan.
Public debt optimists believe that government provides not only productive services, such as infrastructure and social insurance, but also means
of mitigating and correcting supposed “market failures,” such as savings
gluts, economic depressions, inflation, and secular stagnation. Optimists
contend that deficit spending and public debt accumulation can stimulate
or sustain economy activity and ensure full employment, without burdening either present or future generations. To the extent that public debts
become excessive, optimists tend to recommend default, whether ­explicitly
or implicitly (by an inflationary debasement of the currency). Like pessimists, the optimists view financiers and bondholders as essentially
­unproductive, but unlike pessimists they defend a larger economic role
for the state. Almost without exception, optimists reside in the Keynesian
school of political-­economic thought. Among the leading optimists, the
most representative are Alvin Hansen and Abba Lerner.
Public debt realists contend that government can and should provide
certain productive services, mainly national defense, police protection,
courts of justice, and basic infrastructure, but that social and redistributive
schemes tend to undermine national prosperity. Realists say public debt
should fund only services and projects that help a free economy maximize
its potential, and that analysis must be contextualized – that is, related to
a nation’s credit capacity, productivity, and taxable capacity. According to
realists, public leverage is neither inevitably harmful, as pessimists say, nor
infinite, as optimists say. Realists view financiers as productive and insist
that sovereigns redeem their public debts in full, on time, and in sound
money. Realists favor constitutionally limited yet energetic governments
that help promote robust markets. They appear mainly in the classical era
of political-­economic thought. The most representative and renowned of
the public debt realists are Sir James Steuart and Alexander Hamilton.
Public debt pessimists and optimists differ from realists primarily in the
way that they omit crucial context; whereas pessimists focus on the downside of public debt and de-­emphasize its upside, optimists focus on the
upside of it while de-­emphasizing its downside. Realists, in contrast, tend
to consult the wider, most relevant context.


A main thesis of this work is that the public debt realists provide the
most persuasive theories and plausible interpretations of the long, fascinating history of public debt. Moreover, certain puzzles and paradoxes in
contemporary public debt experience – including the recent, multi-­decade
trend of a simultaneous rise in public leverage ratios and decline in public
debt yields, among developed nations – is explicable mainly in realist terms.
In contrast, pessimists and optimists alike offer unbalanced, inadequate
accounts of the public debt record: whereas pessimists are confused or
­mistaken in foreseeing an alleged “inevitable” ruin from public debt, optimists are confused and mistaken about the alleged economic “stimulus”
attainable by large-­scale deficit spending and debt build-­ups. Looking to
the future, the realist perspective will likely provide better i­nterpretations
of public debt policies and trends.
Credit is the most relevant context for debt. The limit of public debt
(see Chapter 5) is circumscribed by public credit, or a sovereign’s capacity to borrow. The greater is public credit relative to public debt, the safer
and cheaper is the borrowing, and the greater the possibility of further
­borrowing at affordable rates. A sovereign may have too much debt relative
to its credit, but its credit alone can never be excessive. As Hamilton (1795)
put it, public credit is the power “to borrow at pleasure considerable sums
on moderate terms, the art of distributing over a succession of years the
extraordinary efforts found indispensable in one, a means of accelerating
the prompt employment of all the abilities of a nation.” As such, “there
can be no time, no state of things, in which Credit is not essential to a
Nation.” Moreover, national credit must rest “on grounds which cannot
be disturbed” and fiscal affairs managed so as “to prevent that progressive
accumulation of debt which must ultimately endanger all government.”
Prior to exploring the theory of public credit and debt in the works of
the leading thinkers of the classical (Chapter 2), Keynesian (Chapter 3),
and public choice (Chapter 4) schools, I present the three-­century empirical record of public debt (Chapter 1). The schools aren’t homogeneous on
public debt theory; pessimists, optimists, and realists can be found in each,
although pessimists tend to congregate in the classical and public choice
schools, while optimists reside in the Keynesian school and realists in the
classical school. Having identified distinct strains of pessimism, optimism,
and realism, and having learned that the realist approach is more persuasive and consistent with history, I apply this perspective to current debate
on the limits of public debt (Chapter 5). Each approach has its proponents
in the contemporary debate, but Chapter 5 conveys realism’s distinctive
analytic advantage.
In examining the three schools of thought, I seek answers to questions
on three levels: nature, causes, and consequences:


The political economy of public debt



questions as to the nature of public credit and debt, including: the
ways of characterizing public credit and public debt, and whether
the two key concepts are distinguished; the view of private debt
versus public debt, and whether or not they are analogous; external
held) debt versus internal (domestically held) debt, and
whether the notion that “we owe it to ourselves” is valid; gross debt
versus net debt, and whether a lower net debt entails less of a burden;
national debt versus public debt (the sum of national plus state and
local debt) and the implications of debt federalism; explicit debt
versus implicit debt (or “off-­balance-­sheet” debt, reflecting longerterm obligations tied to public entitlements); whether it is sensible or
possible to quantify limits to public debt, or its sustainability relative
to national income, taxable capacity, or interest rates;
questions as to the causes of public credit and debt, including: the
extent to which the roots of public debt are ethical-­cultural, political-­
legal, and/or economic-­demographic; whether some regime types
­(autocracy, democracy, intermediate types) are more or less prone to
accumulate excessive public debts; why debts are incurred in wartime
versus peacetime; whether deficit spending and public debts are
temporary or permanent; whether public debt is incurred to fund
transfers and outlays from an operating budget (consumption) or for
capital and infrastructure projects (investment); why a state might
treat minority groups (the rich) or posterity as “fiscal commons”;
questions as to the consequences (or incidence) of public credit
and debt, including: effects on national income, the business cycle,
savings, investment, inflation, interest rates and employment;
whether deficit spending and public debt “­ stimulate” output or job
creation, or instead “crowd out” private-­sector ­activity; the effects
of public debt on the size, scope, and spending capacity of government; its effects on the dependency of a government’s central bank;
and whether, or to what extent the policies buttressing a ­burgeoning
public debt entail “financial repression.”7

Ideology and political regime types also influence public debt policies.
Normatively, they reflect public preferences about the proper purpose,
size, and scope of government, and how public goods should be funded.
Positively, they reflect fiscal-­monetary institutions, which in turn influence
saving, investment, production, interest rates, and prices. Whether public
debt is deemed harmful, beneficial, or innocuous, at root it’s a fiscal derivative of deeper factors; its value ultimately reflects citizens’ demands for
public goods relative to their willingness and ability to pay for them through
taxes, and investors’ willingness and capacity to buy and hold public bonds.


Although fiscal institutions, interacting with voter preferences, shape
fiscal outcomes, the ethical-­ideological norms that determine the size and
scope of government, thus its resort to deficit spending, also tend to guide
preferences for fiscal-­monetary institutions. A democratic citizenry that
demands (and is provided) more public goods than it is willing (or able)
to pay for in taxes will likely oppose institutions designed specifically to
constrain a government’s capacity to borrow or default on its debts. Such
budget amendment or mandatory monetary
restraints as a balanced-­
rules (in place of central bank discretion) will lack popular support. An
electorate that truly opposes deficit spending and large public debts can
simply vote against them, in which case no constitutional-­institutional
fiscal-­monetary restraints would be necessary; in contrast, an electorate
that condones deficit spending and large public debts will vote for them,
in which case no constitutional-­institutional restraints could be effective.
Despite distinct fiscal preferences, democratic political regimes unavoidably render fiscal rules either unnecessary or ineffective. Regardless, it’s not
finance, economics, laws, or budgetary metrics that rule the fiscal world
of unrestrained democracy, but instead the deeper, wider (more popular)
preferences of the prevailing majority. Most political economists take
public preferences as given, yet ideology ultimately determines preferences
and political institutions, for good or ill (Hinich and Munger, 1994). For
this reason, perhaps, public choice scholars, who are more interdisciplinary
than rivals, have usually been more active in public debt debates.
Political ideology has strongly influenced public debt theory. The
theories of the classical political economists embodied the classical-­liberal
(Lockean) conceptions of property rights and limited government that
prevailed in the eighteenth (and much of the nineteenth) century. The
Keynesian theory of public debt evolved in the wake of progressives hope
for an ever-­expanding state, which prevailed so tragically in the twentieth
century. Public choice, while reviving some classical conceptions of public
debt, also recognizes the crucial contemporary influences of unrestrained
In the two centuries prior to 1930 it wasn’t necessary to say much more
about the cause of large public debts than “war.” One might ask why war,
but it wasn’t necessary to ask “Why so much public debt amid war?” It was
no mystery. Only in the last century, with the expansion of unrestrained
democracy, welfare states, and social insurance schemes, have public debt
theorists been obliged to incorporate in their work the powers inherent in
both the warfare state and welfare state. Until 1930 the peacetime “norm”
had been to restore pre-­war budget balance and if possible generate budget
surpluses to permit debt reduction; since 1930, with chronic deficit ­spending
in wartime and peacetime alike, the norm has been perpetual public debt


The political economy of public debt

accumulation. The radical transformation of public finance over the past
century deserves explanation beyond the merely economistic-­positivistic; it
both caused and reflected the vast increase in the size, scope, and power of
the state and its root cause is arguably moral-­ideological-­political.8
No school – whether classical, Keynesian, or public choice – has
eclipsed rivals, at least on public debt theory, which is now broadly
eclectic or narrowly technical. Modern political theory and practice
alike have given the world enlarged state spending relative to GDP,
whether financed by taxes or (increasingly) by debt. Upon reflection
I’ve come to sympathize with public choice theorists, not because they
tend to be debt pessimists, but because they rightly attribute excessive
public debt to unconstrained democracy, noting (uncontroversially) that
political elites’ electoral incentive is to maximize spending, minimize
taxation, and borrow or print money to plug the gap, while treating
wealthy minority groups and future generations as fiscal commons worth
By now it should be obvious that governments borrow most when they
are least willing or able to tax citizens presently and to the full extent
needed to fund outlays. Beyond this, states unwilling or unable to constrain
public spending, yet precluded from borrowing further, on affordable
terms, tend to repudiate their debts, whether explicitly (by non-­payment
of principal and interest), or implicitly (by a deliberate inflation). When
governments borrow to ensure their survival (in war), to effect a near-­term
economic recovery (from depression), or to foster longer-­term prosperity
(through infrastructure), their brief resort to deficit spending need not
persist, nor must debt burdens mount. In contrast, chronic deficit spending may reflect a diminution in the assent of taxpayers to fully support
rising public outlays, even as the resulting accumulation of debt diminishes
public creditors’ expectations of repayment.
Public credit and debt also suffer from a problematic conflict of interest that makes it prone to being abused in unlimited democracies. In any
society governed by a constitutionally limited state, the creditor-debtor
nexus is free and legally secure; to the extent such a state borrows, it obeys
the same norms and rules as market participants. Yet conflict arises when a
less constrained government both adjudicates private creditor-debtor relations and itself becomes a dominant and burdensome debtor in markets.
The unrestrained state is more likely to co-­opt the banking system while
enacting laws and conducting fiscal-­monetary policies that favor its own
­interests at others’ expense.
Whether the causality runs from unconstrained majority rule to imprudent public finance, or the other way around, is less important than their
coincidence and hostility to individual liberty, private property, and


economic prosperity. Direct democracy breeds public profligacy – and the
reverse. They are mutually corroboratory.
At certain times in history, of course, realism demands a candidly negative assessment of political-­economic trends, an interpretation that otherwise seems akin to latent pessimism. The evidence is ample that we’re living
in such a time now, as states globally become more interventionist only a
few decades after the dissolution of the Keynesian consensus and utter
collapse of socialism in Eastern Europe.10 More than 70 years ago, E.C.
Griffith (1945) foresaw the fundamentally anti-­capitalist nature of interventionist states, with their chronic deficit spending and public debt build-­ups:
The philosophy of deficit financing is but one part of a program that creates
basic changes in the reactions of people that, per se, are sufficient to destroy the
system of Capitalism, [which] rests upon the institution of private property, is
motivated by the profit motive, and directed by a price mechanism functioning through the media of the market place. . . Planned economies – of which
a cardinal feature is the policy of deficit financing – are directly opposed to
the continuation of the milieu required for the preservation of the capitalist
system. . . The presence of a national debt created and enlarged for the purpose
of eradicating unemployment will produce an environment that is not conducive to the preservation of the capitalist system. If this proposition is true, then
either the program of deficit financing or the capitalistic system must be abandoned. But when, in a democratic society, this condition becomes apparent, it
will be impossible to abandon deficit financing and, hence, the alternative must
be the abandonment of the capitalistic system.

To be clear, Griffith doesn’t contend that deficit spending by itself destroys
capitalism. The claim would be absurd. He stresses how it’s one part of a
broad anti-­capitalist program: deficit-spending facilitates the evolution of
a larger, more powerful, more invasive, and more redistributive state – all
of which is inimical to private property rights.
A year after Griffith’s essay, Ruml (1946) applauds enlarged state power;
he’s encouraged to see how more powerful central banks, an abandonment
of the restrictive gold standard, and a greater reliance on public borrowing are all making tax revenues “obsolete.” He interprets the same facts
differently, because he opposes capitalism while Griffith favors it. Ideology
­influences assessments of public finance. The anti-­capitalist Keynes (1920)
also favors fiat money, for as its real value “fluctuates wildly,” the
“permanent relations between debtors and creditors, which form the
ultimate foundation of capitalism, become so utterly disordered as to be
almost meaningless,” and “wealth-­getting degenerates into a gamble and a
lottery.” Later, Keynes (1936) also demands “the euthanasia of the rentier”
class (bondholders) by means of low or zero interest rates. Krugman
(2014), Piketty (2014, 2015) and others today advise likewise.


The political economy of public debt

The public debt realists that I examine in this work tend to be more
attentive to moral-­political-­legal issues than their pessimistic and optimistic counterparts. The realist is able to acknowledge genuinely bad times but
also to find a way out. At the end of its Revolutionary War, America was
effectively bankrupt. Incorporating a realist perspective in a 1781 letter
to Robert Morris (then Superintendent of Finance for the Continental
Congress), a young Alexander Hamilton advised against extreme assessments of public credit, and against the notion that public debt is either an
unalloyed benefit or latent harm. “No wise statesman will reject the good
from an apprehension of the ill,” he wrote:
The truth is, in human affairs, there is no good, pure and unmixed. Every
advantage has two sides, and wisdom consists in availing ourselves of the good
and guarding as much as possible against the bad. . . A national debt, if it is
not excessive, will be to us a national blessing. It will be powerful cement of our
union. It will also create a necessity for keeping up taxation to such a degree
which, without being oppressive, will be a spur to industry.11

In place of pessimism or optimism, Hamilton offered a balanced, realistic
perspective, which best explains the full history of public debt – to which
we now turn.

  1. On the burgeoning welfare state, see Browning (2008). On “democracy in deficit” see
Buchanan and Wagner (1977 [1999]), Crain and Ekelund (1978), Balkan and Greene
(1990), Plumper and Martin (2003), Gillette (2004, 2008), Ferguson (2006), Eusepi
and Giuriato (2008), Bruner (2009), Arezki and Brückner (2010), Kane (2012), McKee
and Roche (2012), Motha (2012), Wagner (2012a, 2012b, 2012c), and Catrina (2014).
Addressing recent public debt crises, Bragues (2011) believes “the fault ultimately lies
with democracy. Among the many lessons the current crisis is enjoining us to learn,
the most important is how the political incentives embedded in the architecture of
democracy conduce to the inordinate buildup of public debt. Chronic deficits have
usually been at the root of monetary-­policy failures in the past when central bankers
came under heavy pressure to print money as a politically convenient way to repay the
huge public debt. The deeply held belief that democracy is the best regime keeps us from
noticing all its imperfections.”
  2. Calomiris and Haber (2014) attribute financial sector fragility to populist political pressures. In earlier studies Salsman (1990, 2013a, 2013b) attributed the fragility to modern
central banks devoted more to enabling democratic overseers and underwriting profligate sovereigns than to ensuring sound money or safe banking.
  3. Ciumas et al. (2012) find “strong empirical evidence for the hypothesis that imbalances built up in the private sector would eventually spill over to the public sector
under the form of government deficit and increased public debt.” See also Breton et
al. (2012, p. 57): “In financial crises, private debts typically turn into public debt” and
“sovereign debt may balloon out of control because of actions taken to prevent the
collapse of banking systems.” See also Per Tiwari et al. (2015, p. 2): “banking sector


expansions” “can create significant risks for the sovereign”; “When banking sector
vulnerabilities unravel in banking crises, the risks to the sovereign are further exacerbated by the high fiscal cost of related crisis management policies, particularly bank
bailouts [which are more likely] in countries with larger and more leveraged banking
 4. US Department of the Treasury (2000). See also Reinhart and Sack (2000) and
Kestenbaum (2011).
  5. Reinhart (2012) and Brenner and Fridson (2013).
  6. Turner (2011), Blommestein and Turner (2012a), and Moessner et al. (2012).
  7. On public debt incidence and burdens, see Matsushita (1929), Wright (1940), Smith
(1941), Ratchford (1942), Domar (1944), Reinhardt (1945), Cohen (1951), Meade
(1958), Bowen et al. (1960), Lerner (1961), Modigliani (1961), Neisser (1961), Mishan
(1963), Buchanan (1964a, 1967a), Tullock (1964), Daly (1969), West (1975), Cavaco-­
Silva (1977), Barro (1980), Backhaus et al. (1987), Buchanan and Roback (1987), Stern
(1987), Toshihiro (1988), Blanchard and Missale (1994), Gale and Orszag (2003), Michl
(2006), Yarrow (2008), Laubach (2009), Reinhart and Rogoff (2010), Krugman (2011d),
and Otaki (2015).
  8. On ideology in politics see Hinich and Munger (1994). On the political economy of
public debt see Musgrave (1959), Roubini and Sachs (1989), Verbon and Van Winden
(1993), Brubaker (1997), Neck and Getzner (2001), Winer and Shibata (2002), Bruner
and Abdelal (2005), Brennan (2012), Wagner (2012c), and Theocarakis (2014).
  9. Buchanan (1964b) and Wagner (2012a).
10.See Time (1965), Hicks (1975), Feldstein (1981), and Palmer (1990). More recently, see
Giles et al. (2008), Meacham (2009), and Skidelsky (2009).
11. Hamilton (1781 [1961]).

1.  A brief history of public debt
A concise history of public debt is a prerequisite to understanding its
causes and consequences. Historical context helps corroborate or confute
alternative theories and analytical methods. The good news is that hard
data on public debt and its history have become more comprehensive,
more accurate, and more readily available in recent years.1 Unfortunately,
much contemporary analysis is overly formal, non-­empirical, or focused
myopically on a narrow subset of public debt history that’s not representative of its timeless and valid principles. By one selective reading public debt
may appear sinful, wasteful, and burdensome – by another, moral, productive, and beneficial – and by another still, neither harmful nor beneficial
but merely innocuous.

Governments in ancient and medieval times required funding, as do
modern states, but they didn’t borrow “publically” in the sense of drawing
funds from a wide populace and making it ultimately responsible for
servicing the debt (paying principal and interest), as a form of deferred
taxes. Homer and Sylla (1991) show that private borrowing existed since
recorded history and preceded the development of public borrowing by
many centuries. Eventually, public borrowing became common, but initially involved loans in kind (commodities) instead of in money, for shorter
rather than longer periods, and for war or idiosyncratic purposes rather
than as a permanent funding source. In ancient and medieval times no debt
instruments existed in the forms so familiar to us today – namely, tangible
securities traded in secondary, liquid markets with prices and yields visible
on public exchanges. This form of sovereign obligation emerged in the late
seventeenth century, when the rule of law, sanctity of contract, and parliamentary checks on monarchical power took hold, after Britain’s Glorious
Revolution in 1688.2
In the pre-­commercial feudal era, princes, landlords, and clerics owned
estates or sanctuaries that generated income, not unlike a personal business, but by command-­and-­control operations, with tribute paid by tenant

A brief history of public debt­13

farmers or serfs, in return for military protection.3 Government funds in
the feudal era also derived from the spoils of conquest and war, from the
sale of offices, titles, and indulgences, or by debasing coins at the mint.
Prior to the Renaissance, whenever monarchs, princes, and popes borrowed they did so on their own account, pledging personal income and
estates as security. They often reneged on their debts. Creditors, initially
lured by the prospect of large financial gains, given their privileged proximity to political power, more often than not were mistreated, whether by
defaults, interest reductions, confiscations, or bodily harm.4
In an early account of sovereign debt in ancient times, Bullock (1930)
describes how in the fourth century BC, Dionysus of Syracuse borrowed
from citizens but “repaid” the loan only by debasing the coinage. Today
this is called an implicit (or indirect) default, in contrast to an explicit
or direct one; principal and interest are still paid, but not in the initially
­promised medium of exchange. Governments still resort to this ruse today,
as all now issue fiat paper money. In recent decades a few have issued
indexed public bonds (the United Kingdom since 1982, the
United States since 1997), mainly for information purposes or as policy
guides; they are not a major part of total issuance. The old-­fashioned
term “debasement” has been out of favor for at least a century; today the
tactic is known as “inflationary finance” and the only remaining analytical
controversy is whether public creditors offset its effects by requiring higher
Even though credit–debtor relations developed in ancient times, they
stagnated and reversed in the dark ages and medieval period, due to a
persistent animosity not only to money-­making and commerce but also to
usury (Munro, 2003). Originally usury meant lending money at an interest
rate, not merely at a high rate.5 Aristotle had declared money “barren,” or
unproductive, so interest was an exploitation or theft (Meikle, 1994), but
the ancients were not nearly as hostile to it as their religious successors
subsequent to the fall of the Roman Empire. For a millennium all major
religions condemned, forbade, and punished money-­making and lending
at interest.
Eventually Aquinas provided a qualified defense of lending, which
­coincided with the origin and growth of modern, private banking and
lending, starting in Italy and spreading quickly to Spain and Holland.
With the Protestant Reformation came an unlikely defense of usury, by
Martin  Luther (1524 [1897]). In the Enlightenment of the eighteenth
century, after commerce and lending at interest emerged and flourished
for nearly two centuries, usury received a robust, unqualified defense
by Bentham (1787), which the classical economists – from Smith to
Ricardo and Say and Mill – heartily endorsed. Without a more favorable


The political economy of public debt

attitude toward lending at interest, there would not have been so great
an increase in debt of any kind, including public debt. The more favorable ­philosophical-­cultural attitude toward economic activity and capital
accumulation in general that was so characteristic of the Renaissance and
Enlightenment also made available more lendable funds. Yet the latent
and age-­old (ancient-­medieval) animosity toward bankers and lenders has
never totally dissipated; it was revived in the mid-­nineteenth century by
Karl Marx, with his prejudice against “rentiers” as parasites who induce a
late, crisis-­ridden phase of capitalism, “finance capitalism.”6 Antagonism
towards creditors made it easier (and morally obligatory) for overextended
borrowers, mainly ­sovereigns, to renege on debts or demand forgiveness.7
In contrast, under the classical gold standard era (1870–1913) sovereigns
were better behaved, more credible, and more creditworthy.8
Prior to the seventeenth-­century Renaissance and eighteenth-­century
Enlightenment in Europe, lending to governments meant lending
­personally to rulers, usually monarchs or popes (Cahill, 2010). But these
were largely the personal debts of the rulers, incurred mainly to wage war,
repel invasion, or fund infrastructure projects; technically they were not
“public” debts, in the sense of being based on the paying capacity of the
general public. These were state debts, repayable from the spoils of war or
by the crown’s tax revenues or wealth transfers. Instead of relying on the
precarious practice of borrowing funds under emergency settings like war,
monarchs, princes, and popes preferred instead to amass riches and armies
in advance.
Indeed, mercantilism as a system not only of protectionism and
­regulation but also of public finance, precisely favored policies that built
up, ex ante, the cash holdings of the king and his nation-­state, if necessary
at the expense of citizens or other nations. The aim of a “favorable balance
of trade,” or net exports of goods in excess of their importation, was a
net importation of money (or specie). In this way a monarch amassed a
“war chest” and didn’t have to borrow. In France, mercantilism was personified in finance minister Colbert (1619–83). The German counterpart
to mercantilism was Cameralism, or the art and science of efficiently
­administering royal finances.

The origin and development of today’s modern system of public finance
was made possible by the rise of constitutionally limited, representative government, especially in the wake of Britain’s Glorious Revolution

A brief history of public debt­15

in 1688 and America’s Revolution in 1776 (Fisk, 1920). Each was a
revolt not of peasants or serfs but of the rich and elites (taxpayers and
­rentiers) who were fed up with incessant royal land grabs, arbitrary exactions, cavalier loan defaults, and opportunistic debasements of official
coinage. Parliamentary restraint on the arbitrary powers of royals shifted
the focal point of public finance from the personal finances of monarchs to the financial capacity of the populace and economy at large.
Thereafter, ­government spending, taxing, and borrowing would be undertaken on behalf of the public; instead of bending to royal edicts or caprice,
public finance practices thereafter would hew to regular and predictable
­commercial customs.
The financial revolution of the seventeenth and eighteenth centuries,
which preceded and made possible the Industrial Revolution of the
eighteenth and nineteenth centuries, entailed greater reliance on rule-­
based systems and procedures among creditors and debtors, a greater
­standardization of debt instruments and securities, and secondary markets
where such securities could be traded, rendered more liquid as collateral
for further borrowing.9 As debt securities became publicly traded and
more visible, so also did their prices and yields; a transparent window
was opened on the reputation and credibility (or lack thereof) of debtors
generally, and sovereign debtors in particular recognized that they could,
by credible commitment and demonstrated creditworthiness, borrow more
easily and regularly at lower interest rates relative to rivals, and that
­borrowing power could be enormously advantageous in wartime, when
debt finance was politically preferable to higher taxes. No longer was it
necessary to accumulate royal riches in advance. After 1650 public borrowing began in earnest in the Italian republics of Genoa and Venice, next in
the United Provinces (Netherlands), and soon thereafter (especially after
1688) in England and France (Fritschy, 2003; Carlos and Neal, 2011).
History makes clear that during the multi-­century, post-­medieval shift
from absolute monarchies to today’s virtually unrestrained democracies,
there existed, in the eighteenth and nineteenth centuries, a third and better
way: constitutionally limited commercial republics (the United States
included) where rights were respected most and economies performed
best (MacDonald, 2003). There public credit was sound because the
state itself was restrained. Suffrage was limited and representatives were
“natural” aristocrats (manufacturers, merchants, bankers) not the lawyers
or political careerists drawn from all too common pools. The “Republic of
Rentiers” (my own nomenclature) properly and profitably eschewed the
capriciousness and chaos common to autocracy and democracy alike.
The transition from arbitrary rule by whim and by men to rule by
­pre-­established legal precedent fostered a vast expansion of credit–debtor


The political economy of public debt

relations, including those between government (as debtor) and private
creditors. Whereas most public debt scholars have argued that more
­representative forms of constitutional government encouraged responsible
public debt issuance, some argue a reverse causation – that burgeoning
public debt itself expanded democracy and freedom (ibid.). But the past
century has seen not merely a vast extension in suffrage and more direct
forms of democracy, but also the spread of public fiscal imprudence.10
In the eighteenth and nineteenth centuries, public debt expanded mainly
during wartime, then contracted in peacetime, relative to national income,
but in the more democratic past century, deficit spending and high public
debt ratios have become the norm, despite cyclicality and wars, and rise
even in peacetime.
Of great importance to the historical development of public debt, during
­ arehouse
the Renaissance, private banks shifted from providing mere w
services for clients’ specie into fractional-­
reserve institutions that lent
a portion of deposits at interest, with assets now a mixture of precious
metals and loans – what Carroll (1855–79 [1964]) called the “organization
of debt into currency.” Instead of currency backed by specie only, it was
backed by specie plus debts owed to banks by borrowers. Initially currency
was still redeemable at a fixed weight of specie, and not as yet monopolized
by government or issued by states without backing (as we have today). This
manner of backing currency partly with debt was eventually and gradually
adopted by money-issuing central banks.
During the first two centuries of public debt issuance (the ­eighteenth and
nineteenth centuries) coupon rates were low relative to prior ­experience,
typically 3–6 percent (Homer and Sylla, 1991), because most sovereigns
were fiscally prudent. They issued large sums of debt amid war, but
­otherwise eschewed chronic budget deficits. In peacetime they also used
various pre-­commitment devices – sinking funds, annuities, and the gold
standard – to assure creditors of timely repayment in money that would
hold its value over time.11
For much of US history the federal government employed sinking funds
to enhance the credibility of its commitment to service its debts. Annual
budget appropriations would include a set-­aside of sums to accumulate
in an escrow-­type fund to be used to repay the principal of public debt
at maturity. The fund was also used to periodically purchase undervalued
public bonds; the Treasury could selectively redeem those of its bonds that
were trading below par, which boosted bond prices and investor confidence. Public bond prices were less volatile, thus more attractive to hold.
Public annuities were also used; instead of paying interest only during the
life of a public bond, then a single, large principal payment at ­maturity,
an annuity paid both interest and a steady portion of the principal

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