Some readers thought I buried the lead in this post on recent debates around debt stabilization. In this conclusion to that piece, I wrote:
…economic growth is really the most overlooked variable here. At least in my lifetime, the only time I’ve ever seen the debt ratio fall in earnest was when the economy was at full employment. Though we relentlessly target the numerator of the debt ratio, the real action is in targeting the denominator. That doesn’t invite fiscal profligacy—if you want to hang with the cool kids, you’ve got to be a CDSH [cycical dove, structural hawk]. But it does suggest that once again, we’re looking for fiscal rectitude in all the wrong places.
So where’s the evidence for that claim? I was largely thinking about the 1990s, when real GDP grew fast enough to more than close the output gaps present in the early part of the decade. The figure below plots output gaps, defined as the percent that potential GDP is above or below actual GDP, against percentage point changes in the debt/GDP ratio. The circled part shows the output gap in the 1990s moving from out -5% to +5%, against a huge slide in the debt/GDP ratio, from 49% in 1993 to about 33% in 2001.
But the first part of the figure is informative as well–GDP was mostly above potential in those years, meaning there were relative few periods of negative output gaps, and the debt ratio was mostly falling.
Now, of course, much of these movements are mechanical and cyclical: growth falters, output gaps grow, and as anti-recessionary measures ramp up and fewer revenues flow in, government debt rises–that’s why the negative correlation, shown in the table, is quite large (-0.78). But that’s just another way of saying there’s no plausible reason to jam growth in the interest of deficit or debt reduction. It won’t work.
To close out, over to the great John Cassidy from a recent post on UK austerity:
In short, the U.K. experience shows how austerity policies, when applied without regard to the state of the economy, often lead to more government borrowing and debt creation, not less. In the past few years, we’ve seen pretty much the same thing happen in other European countries: Greece, Ireland, Portugal, and now Italy and Spain. Still, though, many proponents of austerity refuse to acknowledge their errors.
Sources: OMB, CBO, BEA