A government running a Ponzi scheme with debt is like a homeowner canceling his fire insurance to save money or an investor selling deep out-of-the-money puts: It works most of the time, but when it doesn’t, all hell breaks loose.

– N. Gregory Mankiw, May 2022

It’s fashionable once again in Europe to talk about fiscal policy. We point to the current fight over what to do with taxes among the U.K.’s Conservative Party candidates to replace Boris Johnson as prime minister—Liz Truss wants to lower them immediately, while Rishi Sunak wants to increase them until he’s sure inflation is contained. In addition, there are renewed concerns about rising Italian bond yields, and what might happen to policy following the resignation of the technocrat prime minister Mario Draghi (which has again shone a spotlight on Italy's 183% debt to GDP and large budget deficits). This is not yet the case in the United States, where the focus is still largely on the Federal Reserve and monetary policy.

Yet, as rate increases and inflation bite and the economy slows, there will inevitably be calls for fiscal policymakers to “do something” to offset any pain, meaning that the debate here will once again shift back to the government’s balance sheet and how much room there is to maneuver at a time when its finances have already been stretched thin by the pandemic. In this Economics Weekly, we discuss the current thinking around debt and what kind of discussion we might expect to see going forward.

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Richard de Chazal, CFA, is a London-based macroeconomist covering the U.S. economy and financial markets.