One way I get a bead on what folks are thinking about is when lots of people start asking the same question. Well, over the past week, a lot of people have been asking about the relationship between a country’s debt level and its growth.
This seems to have been precipitated by a couple of prominent debt alarmists—Reps Boehner and Ryan—both admitting that we don’t have a near-term debt crisis, though they were quick to add that unless we cut everything in sight we’d shortly thereafter be crushed by our debt burden.
In other words, what’s tricky about sorting this out is that there are many in the debate whose shrink-the-government agenda is strongly aided by alarmism. That doesn’t mean that there’s, in fact, no relationship between debt and growth. But it does mean you won’t learn about it from Reps Ryan or Boehner.
So what does the economic evidence show? Here’s a nice summary from Bloomberg, and here are the key points as I see them:
–Our public debt ebbs and flows in ways that make it virtually impossible to sort out conclusive growth impacts. Most notably, because of higher automatic spending and lower tax revenues, the public debt share of GDP rises in recessions, building in a negative correlation between growth and debt…
–…but one that is entirely meaningless in terms of concluding anything about growth impacts. In fact, we very much want our debt share to rise in recession, as the federal government is the one sector that can offset the private sector contraction. The causality, as Irons and Bivens (I&B, more on them below) point out in a highly readable paper on this stuff, thus runs from slow growth to high debt.
–So the only stories that make sense here are longer-term ones, and the main channel through which public debt would damage growth is through “crowding out” wherein a highly indebted government competes with private investors for scarce capital, leading to higher interest rates and slower growth.
–There’s little evidence for this, especially as regards debt, as stressed by I&B. You can weave stories about how high sovereign debt levels lead investors to demand an interest rate premium against default risk, but that’s much less of an issue for own-currency countries with an active central bank like the US (unlike Greece or Cyprus).
–But what about those warnings from Rogoff/Reinhart and others that once your debt ratio crosses 90%, you’re toast?! Sorry, but again, when you look at the US historical record or that of other sovereign currency countries, that correlation (and again, it’s just a correlation to which its author commit a classic no-no by assigning causality) isn’t there. I&B show, for example, that a prominent claim re this 90% threshold in the US is wholly a function of the defense buildup and demobilization around WWII in the 1940s.
–That example underscores the point that there are tons of moving parts here. I’ll assume that even the hawkiest debt hawk would have supported defeating Nazism, which brings me to a key point that is often missed in this debate.
–You simply can’t condemn or embrace debt accumulation based on a single number, like it’s share of GDP or how many trillions it is. You have to evaluate a) what it’s being used for, and b) its trajectory.
–Re “a,” fighting an existential enemy, investing productive public goods, and of course, servicing the debt (paying interest to investors) is different than borrowing a lot of money to pay for inefficient health care. Borrowing to invest and promote future growth or to offset a deep recession makes sense. Borrowing to increasingly support a public health care system that is fraught with waste does not.
–So should we worry at all about our debt? While I don’t worry much about interest rates and crowding out, there are two reasons to be concerned about debt ratios rising in good times. First, at whatever rate of interest prevails, the larger the stock of public debt, the more national income we’ll have to devote to interest payments, and, controlling for the investment/Keynesian agenda I endorsed above, that’s something you want to watch out for. Second, if our debt-GDP-ratio is high and rising during recoveries, good luck getting Congress to agree to the steeper increase needed to offset the next recession.
So, my message re the public debt isn’t “don’t-worry-be-happy.” It’s don’t listen to anyone whose hair’s on fire about this or to those touting hard thresholds above which doom awaits. Instead, make sure our spending and revenues are aligned such that the debt stabilizes and comes down as a share of the economy once a solid recovery takes hold. And instead of obsessing about the level of the debt, obsess about what it is we’re spending it on.