Based on what’s happened in Greece and other European nations, we know from real-world evidence that even nations from the developed world can spend themselves into debt trouble.
This has led to research that seeks to pinpoint when debt reaches a dangerous level.
Where’s the point where investors stop buying the debt? Where’s the point when interest on the debt becomes too much of a burden?
Most famously, a couple of economists crunched numbers and warned that nations may reach a tipping point when debt is about 90 percent of GDP.
I was not persuaded by this research for two reasons.
First, I think it’s far more important to focus on the underlying disease of too much government, and not get fixated on the symptom of too much borrowing. If I go see a doctor because of headaches and he discovers I have a brain tumor, I want him to address that problem and not get distracted by the fact that head pain is one of the symptoms.
Second, there are big differences between nations, and those differences have a big effect on whether investors are willing to buy government bonds. The burden of debt is about 240 percent of GDP in Japan and the nation’s economy is moribund, for instance, yet there’s no indication that the “bond vigilantes” are about to pounce. On the other hand, investors are understandably leery about buying Argentinian government debt, even though accumulated red ink is less than 40 percent of economic output.
So what about America, where government borrowing from the private sector now accounts for 82 percent of GDP? Have we reached a danger point for government debt?
According to Matthew Yglesias (who says I’m insane and irrational), the answer is no.
I have several comments on this video.
1. Some people have complained that the video is deceptive because it focuses on debt held by the public rather than the gross federal debt. The video could have been more explicit and explained why that choice was made, but I have no objection to the focus on publicly-held debt. After all, that’s the measure of what government has borrowed from the private sector. The gross federal debt, by contrast, also includes money the government owes itself (such as the IOUs in the Social Security Trust Fund), but that type of debt is merely a bookkeeping entry.
2. The video asserts that inflation is low and therefore we don’t have to worry that government might have to “print money” at some point to finance additional debt. I don’t think there’s any immediate danger that the Fed will be put in a position of financing the federal government, but I nonetheless don’t like this logic. It’s sort of like saying it wouldn’t be a problem to start eating ten pizzas per day because you currently aren’t heavy. The simple truth is that low inflation now doesn’t mean low inflation in the future.
3. I also reject the assumption in the video that interest rates drive the economy. Indeed, it’s probably more accurate to say that the economy drives interest rates, not the other way around. Suffice to say that the video is based on the same thinking that led the Congressional Budget Office to imply that you maximize growth by putting tax rates at 100 percent.
4. The video also warns that politicians shouldn’t raise taxes or reduce government benefits since either policy would “take money out of people’s pockets.” This is Keynesian economic theory, which I’ve explained many times doesn’t make sense. No need to regurgitate those arguments here.
5. Which brings us to the main problem of the video. It ignores the problem of unfunded liabilities. More specifically, it doesn’t address the fact that politicians have made commitments to spend far too much money in the future, largely because of poorly designed entitlement programs. And it is these built-in promises to spend money that give America a very grim fiscal future, as show by this BIS, OECD, and IMF data.
Here’s the video, produced by the Center for Prosperity, that accurately puts all this information together (the data is now several years out of date, but the analysis is still spot on).
Remember, the problem – both today and in the future – is the burden of government spending.
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re: “Some people have complained that the video is deceptive because it focuses on debt held by the public ”
Yup, there are more important problems with that video to debunk than quibbling over whether he used the right term. Though I will suggest that the total national debt is a better figure to focus on since even though it may be merely an “accounting” detail, unless something changes it will need to be paid, just like the projected unfunded liabilities you rightly stress as being a major concern.
The biggest thing as you say is that future interest rates, inflation, and GDP growth are unpredictable and could change for the worse tomorrow for all we can know for sure, budgets should be based on worst case scenarios for all of them. He does seem to think the Fed could merely print money to keep up with it, despite the fact that if it goes overboard doing so in the future when the economy is healthier, that would lead to higher inflation rates. Higher inflation isn’t something the private sector likes, and it tends to lead to higher interest rates which will likely make the debt situation worse (since it is likely if a pattern of higher inflation is expected that investors will raise the interest rates and not let the debt be inflated away, since the debt tends to mature within a few years and roll over, there is an explanation of the concern on this page:
http://www.politicsdebunked.com/article-list/budget-lottery
Look for “inflation may make things worse”, it is an arguable point).
It is true that QE hasn’t let to the level of inflation many might have predicted, but the economy improves and banks lend more that may change. As Robert Higgs has pointed out (search at Independent.org ) that is partly because banks tightened lending standards which inhibited money growth from that (stricter lending standards is one of the reasons we’ve had lower interest rates despite government borrowing crowding out the private sector, increased lending standards reduced demand, in addition to more technical aspects of changes in interbank lending).).
[…] « Is Government Debt a Problem? […]
The word that i don’t find in this post, is “default”.
I don’t see the point of discussing whether public debt is a problem, without addressing the risk of default.
Debt is a “sand castle” problem. As it grows relative to size of the economy, the structure becomes more unstable. Even a single additional grain of sand could cause a cascade.
The only way to gauge how unstable debt has become is the level of interest rates above the inflation rate. One assumes that bond buyers are sophisticated enough to demand the appropriate risk premium.
However, it’s not that simple. With the Fed pushing interest rates down and foreign buyers looking at the US as a safe haven, there are factors camouflaging the underlying situation.
All we can say for sure is that the castle is still standing, but growth relative to GDP is adding instability. If Japan, France, or Greece’s castles should fall; our situation will change radically. It could implode with the others, or it could scare the pants off legislators and force adjustments to spending.
We only know that the “Mitchell Rule” will improve the stability of our castle.