The Effect of Government Debt
There was a study on the economic effects of government debt drafted in January of 2010 called Growth in a Time of Debt. It was written by a professor from Harvard and one from the University of Maryland. Here are some quotes (followed by my comments):
"For the five countries with systemic financial crises (Iceland, Ireland, Spain, the United Kingdom, and the United States), average debt levels are up by about 75 percent, well on track to reach or surpass the three year 86 percent benchmark that Reinhart and Rogoff (2009a,b) find for earlier deep post-war financial crises."
-- Growth in a Time of Debt, page 4
"In principle, the manner in which debt builds up can be important. For example, war debts are arguably less problematic for future growth and inflation than large debts that are accumulated in peace time. Postwar growth tends to be high as war-time allocation of manpower and resources funnels to the civilian economy. Moreover, high war-time government spending, typically the cause of the debt buildup, comes to a natural close as peace returns. In contrast, a peacetime debt explosion often reflects unstable underlying political economy dynamics that can persist for very long periods."
-- Growth in a Time of Debt, page 6
Looking at the debt levels of the 20 most advanced countries in the world:
"From the figure, it is evident that there is no obvious link between debt and growth until public debt reaches a threshold of 90 percent. The observations with debt to GDP over 90 percent have median growth roughly 1 percent lower than the lower debt burden groups and mean levels of growth almost 4 percent lower. (Using lagged debt should not dramatically change the picture.) The line in Figure 2 plots the median inflation for the different debt groupings—which makes plain that there is no apparent pattern of simultaneous rising inflation and debt."
-- Growth in a Time of Debt, page 7
"There are exceptions to this inflation result, as Figure 3 makes plain for the United States, where debt levels over 90% of GDP are linked to significantly elevated inflation."
-- Growth in a Time of Debt, page 9
"Interestingly, introducing the longer time series yields remarkably similar conclusions. Over the past two centuries, debt in excess of 90 percent has typically been associated with mean growth of 1.7 percent versus 3.7 percent when debt is low (under 30 percent of GDP), and compared with growth rates of over 3 percent for the two middle categories (debt between 30 and 90 percent of GDP). Of course, there is considerable variation across the countries, with some countries such as Australia and New Zealand experiencing no growth deterioration at very high debt levels. It is noteworthy, however, that those high-growth high-debt observations are clustered in the years following World War II."
-- Growth in a Time of Debt, page 11
Post-crisis private debt tends to show deleveraging and exacerbate high unemployment:
"Private debt, in contrast to public debt, tends to shrink sharply for an extended period after a financial crisis. Just as a rapid expansion in private credit fuels the boom phase of the cycle, so does serious deleveraging exacerbate the post-crisis downturn. Just as a rapid expansion in private credit fuels the boom phase of the cycle, so does serious deleveraging exacerbate the post-crisis downturn. This pattern is illustrated in Figure 7, which shows the ratio of private debt to GDP for the United States for 1916-2009. Periods of sharp deleveraging have followed periods of lower growth and coincide with higher unemployment (as shown in the inset to the figure). In varying degrees, the private sector (households and firms) in many other countries (notably both advanced and emerging Europe) are also unwinding the debt built up during the boom years. Thus, private deleveraging may be another legacy of the financial crisis that may dampen growth in the medium term."
-- Growth in a Time of Debt, page 21
Figure 7 on page 22 of Growth in a Time of Debt shows private debt has reached 270% of US GDP, the highest in a century and perhaps the highest ever.
"…Seldom do countries simply "grow" their way out of deep debt burdens.
"Why are there thresholds in debt, and why 90 percent? This is an important question that merits further research, but we would speculate that the phenomenon is closely linked to logic underlying our earlier analysis of "debt intolerance" in Reinhart, Rogoff, and Savastano (2003). As we argued in that paper, debt thresholds are importantly country-specific and as such the four broad debt groupings presented here merit further sensitivity analysis. A general result of our "debt intolerance" analysis, however, highlights that as debt levels rise towards historical limits, risk premia begin to rise sharply, facing highly indebted governments with difficult tradeoffs. Even countries that are committed to fully repaying their debts are forced to dramatically tighten fiscal policy in order to appear credible to investors and thereby reduce risk premia."
-- Growth in a Time of Debt, page 22
"…countries that choose to rely excessively on short term borrowing to fund growing debt levels are particularly vulnerable to crises in confidence that can provoke very sudden and "unexpected" financial crises. Similar statements could be made about foreign versus domestic debt, as discussed. At the very minimum, this would suggest that traditional debt management issues should be at the forefront of public policy concerns."
-- Growth in a Time of Debt, page 23
Source: Growth in a Time of Debt was prepared by Carmen M. Reinhart (University of Maryland) and Kenneth S. Rogoff (Harvard University) in January, 2010, for the American Economic Review Papers and Proceedings. It is available as a pdf file at:
http://www.economics.harvard.edu/faculty/rogoff/files/Growth_in_Time_Debt.pdf
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Comments by the Blog Author
A "deal" to raise the debt limit achieved on Sunday, July 31, 2011. The existing debt level is $14.3 trillion in debt for a USA economy with a GDP of $14.8 trillion. The agreement:
Raises the debt above 100 percent of GDP for the USA
Skips requiring a Congressional vote on a balanced budget amendment
Does not disallow further tax increases
Does not specify a baseline
Reduces spending between now and January of 2013 by only a puny amount
Will probably be funded by short-term debt (inviting another crisis)
Invites higher inflation and a lower growth rate (as debt exceeds 90% of GDP)
Does nothing to reduce the huge level of private debt (which elevated level hasn’t reduced unemployment)
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