Trillions of US dollars have been spent globally to support economies hit by the Covid-19 pandemic. The greatest part of this spending has been financed by government via issuance of government bonds, most of which have been purchased by central banks. This has been truer in advanced economies, where central banks enjoy more credibility, than in emerging ones, where central banks and economic institutions in general have a less proven track record. Central banks have also increased credit to the private sector, which – thanks also to government sponsored programmes, such as guarantees or moratoria on credit – has grown substantially, especially in Europe. In the US, the expansionary monetary policy has made it easy for firms to issue bonds on the market to bridge the loss of revenues incurred during the pandemic.

The world will exit from the Covid-19 crisis with a certain number of problems, but high on the list will be the increased levels of public and private debts. Leaving aside the thorny issue of the debt of the more fragile and poorer states, which will require official and private creditors to find agreement over some form of write-off and debt relief, this increased debt is not yet a concern. As long as inflation remains subdued and interest rates remain contained, the debt burden, in terms of the cost of servicing this higher debt, should not increase substantially compared to the pre-pandemic levels. The Magic Money Tree however will no longer be so magical, much to the disappointment of policy-makers.

Private debt levels will reach new heights, as will those of public debt. A point will be reached when central banks and commercial banks will not be able to extend much new credit without burdening their balance sheets with significant risks. In Chapter 4 we discussed how potential balance sheet losses would constrain the margin of manoeuvre for central banks. At that point, the Magic Money Tree will cease to exist and the budget constraint will regain its central role.