A mis­placed ob­ses­sion with debt

The Olympian - - Opinion - BY PAUL KRUG­MAN

Do you re­mem­ber the win­ter of debt?

In late 2010 and early 2011, the U.S. econ­omy had barely be­gun to re­cover from the 2008 fi­nan­cial cri­sis. Around 9 per­cent of the la­bor force was still un­em­ployed; long-term un­em­ploy­ment was es­pe­cially se­vere, with more than 6 mil­lion Amer­i­cans hav­ing been out of work for six months or more. You might have ex­pected the con­tin­u­ing em­ploy­ment cri­sis to be the fo­cus of most eco­nomic pol­icy dis­cus­sion.

But no: Wash­ing­ton was ob­sessed with debt. The Simp­son-Bowles re­port was the talk of the town. Paul Ryan’s im­pas­sioned (and, of course, hyp­o­crit­i­cal) de­nun­ci­a­tions of fed­eral debt won him me­dia adu­la­tion and awards. And be­tween the cap­i­tal’s debt ob­ses­sion, the Repub­li­can takeover of the House, and a hard right turn in state gov­ern­ments, Amer­ica was about to em­bark on a pe­riod of cut­backs in gov­ern­ment spend­ing un­prece­dented in the face of high un­em­ploy­ment.

Some of us protested bit­terly against this pol­icy turn, ar­gu­ing that a pe­riod of mass un­em­ploy­ment was no time for fis­cal aus­ter­ity. And we were mostly right. Why only “mostly”? Be­cause it is be­com­ing in­creas­ingly doubt­ful whether there is any right time for fis­cal aus­ter­ity.

That is the mes­sage I take from Olivier Blan­chard’s pres­i­den­tial ad­dress to the Amer­i­can Eco­nomic As­so­ci­a­tion. To be fair, Blan­chard – one of the world’s lead­ing macroe­conomists, for­merly the ex­tremely in­flu­en­tial chief econ­o­mist of the IMF – was cau­tious in his pro­nounce­ments, and cer­tainly did not say that debt never mat­ters. But his anal­y­sis none­the­less makes the Fix the Debt fix­a­tion (yes, they are still out there) look even worse than be­fore.

Blan­chard starts with the ob­ser­va­tion that in­ter­est rates on gov­ern­ment debt are quite low, which in it­self means that wor­ries about debt are overblown. But he makes a more spe­cific point: The av­er­age in­ter­est rate on debt is less than the econ­omy’s growth rate (“rg”). More­over, this is not a tem­po­rary aber­ra­tion: in­ter­est rates less than growth are ac­tu­ally the norm, bro­ken only for a short stretch in the 1980s.

Why does this mat­ter? There are ac­tu­ally two sep­a­rate but re­lated im­pli­ca­tions of low in­ter­est rates. First, fears of a ru­n­away spi­ral of ris­ing debt are based on a myth. Sec­ond, rais­ing pri­vate in­vest­ment should not be a huge pri­or­ity.

On the first point: Di­a­tribes about debt of­ten come with omi­nous warn­ings that debt may snow­ball over time. That is, high debt will mean high in­ter­est pay­ments, which drive up deficits, lead­ing to even more debt, which leads to even higher in­ter­est rates, and so on.

But what mat­ters for gov­ern­ment sol­vency is not the ab­so­lute level of debt but its level rel­a­tive to the tax base, which in turn ba­si­cally cor­re­sponds to the size of the econ­omy. And the dol­lar value of GDP nor­mally grows over time, due to both growth and in­fla­tion. Other things equal, this grad­u­ally melts the snow­ball: even if debt is ris­ing in dol­lar terms, it will shrink as a per­cent­age of GDP if deficits are not too large.

The clas­sic ex­am­ple is what hap­pened to U.S. debt from World War II. When and how did we pay it off? The an­swer is that we never did. Yet, de­spite ris­ing dol­lar debt, by 1970 growth and in­fla­tion had re­duced the debt to an eas­ily han­dled share of GDP.

Blan­chard’s sec­ond point is sub­tler but still im­por­tant. In gen­eral, debt scolds warn not just about threats to gov­ern­ment sol­vency but about growth. The claim is that high pub­lic debt feeds cur­rent con­sump­tion at the ex­pense of in­vest­ment for the fu­ture. And high debt does in­deed prob­a­bly have that ef­fect when the econ­omy is near full em­ploy­ment (al­though in 2010-2011 more deficit spend­ing would have led to more, not less, pri­vate in­vest­ment).

Blan­chard does not say this, but what we should prob­a­bly be wor­ry­ing about in­stead of debt is pub­lic in­vest­ment in in­fra­struc­ture, which has been ne­glected and suf­fers from ob­vi­ous de­fi­cien­cies.

Yet the debt ob­ses­sion led to less, not more, pub­lic in­vest­ment. Pub­lic con­struc­tion spend­ing as a per­cent­age of GDP rose briefly dur­ing the Obama stim­u­lus ( partly be­cause GDP was down), then plunged to his­tor­i­cally low lev­els, where it has stayed. For all the talk about tak­ing care of fu­ture gen­er­a­tions, debt scolds have al­most surely hurt, not helped, our fu­ture prospects.

Newspapers in English

Newspapers from USA

© PressReader. All rights reserved.