At what point does public debt become a problem? If you ask many Republicans when the debt hits 90% of GDP we’re in trouble. Given that the Federal Debt is above this level you can see why there is a push for budget control if not outright austerity. But where did that magic figure come from?
The answer is a work by two Harvard economists, Reinhart and Rogoff’s 2010 paper “Growth in a Time of Debt.” But now that this magic number has been debunked in spectacular style, will the call for austerity ease? Given how the sides have retrenched, no way. But it is true that a certain level of debt is indeed a problem – it just isn’t something you can pull from a formula and throw onto autopilot.
It all starts with the paper from 2010, released about the same time the Tea Party was gaining ground. Reinhart and Rogoff aren’t extremists but economists genuinely concerned about debt and how it affects the economy. Yet their reasoned concerns were little more than gasoline for a political fire and were soon burning brightly. The idea that public debt caused the slowdown became canon in many circles.
Earlier this year Thomas Herndon, a 28-year-old economics grad student at UMass Amherst, was writing his critique of the work. A simple request for more information to Prof. Carmen Reinhart nabbed him the original spreadsheet. It didn’t take long for Herndon to find the problem. “I clicked on cell L51, and saw that they had only averaged rows 30 through 44, instead of rows 30 through 49.” By leaving out Canada and Australia, nations with high public debt and high growth, the whole argument was skewed. The original paper fell apart.
Or did it?
The team of economists have been very prolific, and in 2011 published their book “This Time is Different” which included this paragraph:
If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is.
Not exactly Tea Party stuff – it doesn’t have that magical drop-dead figure of 90% that can drive policy. But a lot of debt, from any source, is a huge drag on the economy. File that under “duh” if you want to, but let’s look at how the public part of the debt, the part that we’re all uptight about, has fared since 1996, as a share of the economy:
You can see three distinct trends here. By October 2000 the total debt had fallen to 56% of the economy – our first inflection point in this graph. From there, it grows through the early part of the Managed Depression to 66% of GDP, showing as we noted before that debt from deficit spending was growing faster than the economy as a whole. And from 2008 on we have TARP and collapse – the chart simply takes off.
The three phases of the chart show what a non-hysterical and reasonable discussion should be about our debt today, and the three lessons that are important:
1. The way you deal with debt is always, at least in part, to grow into it,
2. When debt is growing faster than the economy something is seriously wrong, and
3. Right now there is good reason to believe that debt is increasing in a dangerous way.
That’s not what we generally hear, either from economists or politicians. But there is plenty of reason to believe that at some point the accumulated debt does slow down growth – and not just public debt. Are we there yet? Hard to say, but we do need to get this under some control. But should we pull back hard and enforce austerity? No, debt is best handled by growth, so a complete pullback would be counter-productive. But haven’t we been spending faster than the economy is growing for some time? Sure – so whatever we’ve been doing has been the wrong thing.
It goes without saying that some spending by the government is more “stimulating” than others. Unemployed people that might otherwise collect benefits can be put to work rebuilding infrastructure, for example. The economy is clearly restructuring as it finishes the transformations caused by disruptive technology changes – so what can we do to push these along? Keep in mind that even in the New Deal the deficit never exceeded 5% of GDP (versus 10% today).
The belief that a spreadsheet can give us a magic number to govern by is ridiculous. Apparently, the result many were working with was simply wrong, too. For all that, we’ve been running far more interesting experiments for the last two decades and seen far more interesting results.
If you really need a number, remember that in both economics and politics 90% of what you see is BS. At least.
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You can never put government on autopilot – it’s a recipe for disaster! Good article.
Thank you!
It’s not the debt that is the problem, it is the interest rate charges on existing debt that result in a never ending debt treadmill ride that is the problem.
They do go together. But yes, it is creating a society that is always paying the idle who have found themselves controlling the capital that is the problem. We see that in southern Europe right now, too.
I would like to see some field studies instead of so much macroeconomic writing. It seems to me with the persistent high unemployment which was accurately predicted after the crash of 2008. And the shredding of jobs in 2009 and cutting in public employment in 2010, that new social norms esp. regarding the labor market and work environment are taking place.
In no way is this a criticism of your post or Krugman’s but it seems to be the way Washington works. Because in many ways Washington does not work very well. Look at last weeks gun control defeat by the minority of senators. Or the lax regulation in Texas and the fertilizer blast.
It does come back to jobs. I was challenged on facebook to look at sustainable growth, which is more equitable – and I accept that. Jobs are a big part of that sustainability – does everyone have work?
Washingtoon? Bleh. The lax regulation is a big problem, yes, and part of a playing field that is not level by any means – and leads to disasters.
I feel embarrassed for them because I have done things like that. But this became such a big deal on a bad spreadsheet! How awful! But they did have a point that at some point debt is crushing and not just for nations but for anyone. That does seem obvious and I have seen it a lot of times. You just can’t get out from under it and all your energy goes into worrying about it. I would call that a “duh”!
I go between empathy for a bonehead move and a feeling that they stopped error-checking when they had the answer they wanted. We all do that, but … in this case it’s driven policy around the world. Not good.
But yes, it’s clear that excessive debt is a problem. I just don’t like focusing exclusively on public debt – it’s all bad.
Also did you heat the Koch brothers are thinking of buying the major media properties in Chicago and LA plus other states? If they can control the media like that perhaps some government ownership would be better.
The Koch Brothers really scare me. They have a very limited sense of reality, which probably comes from the fact that they inherited their money.
Good blog. Seen too many crowing about the goof R&R made, glad to see someone show that the principle still holds.
Thanks – yes, I don’t want people to think debt is totally unimportant. It’s all relative – and frankly right now private debt scares me a LOT more. It is about 4 times as big.
Should journals require authors to upload #replication data upon article submission?
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I think the Reinhart-Rogoff replication scandal has not only consequences for how we think about debt. It might well change the way we think about replication and data sharing in the social sciences. Reproducibility issues in the social sciences had already become more prominent after the twitter hype on #overlyhonestmethods (http://tinyurl.com/cv7za9o), but now I’ve talked to a few journal editors and fellow scholars and it seems things are moving. More and more journals in the social sciences are rethinking their replication policies, and I think the social sciences can learn much from the natural sciences’ guidelines. So far, most journals do not ask authors to give proof that they uploaded their replication data somewhere. I think changing this would be the way forward: http://wp.me/p315fp-fZ.
This is a very good point. Note that a very simple request got the spreadsheet without any fuss at all. Why was this not done before?
The implications of works published by economists are at least as important as anything in natural science, if not moreso – they tend to affect policy, and do it rather quickly. I hope things are changing.
Thank you for your comment, this is very important.
“works published by economists are at least as important as anything in natural science” Agreed!
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At what point does public debt become a problem? The answer is simple; when the market becomes scared over the debt. The whole process is human driven so there is no single formula to estimate it. When the market becomes scared they demand high interest to alleviate their risks. Once interest rates go up then the country is saddled both with debt and high payments which make it extremely difficult to reduce debt. That is when it is problem.
On the plus side the US is insulated to the market concerns over debt to some extent. That is because USD is a reserve currency and used heavily in international trade. Until the market finds a better alternative the US will be relatively protected from this cycle. Few will want to hike up interest on the US when it will hurt everybody holding US debt. But if another currency becomes viable in the eyes of the market then US could be in big trouble.
Absolutely – we have our way as the people who print the world’s currency. But that is indeed coming to an end, if slowly, as we reported here a year ago and the effects are just starting to take hold. I think it’s time to look back into it, thanks for the reminder.
And I’ve long been a supporter of a global currency as a reference, too.
What would that do to us? It would sure end the party. But I am sure that is coming no matter what. Until then, we get to do pretty much what we want. I think it’s best to be prudent – and we are in far better shape than most developed nations already. Makes you wonder given our Congress, eh?
Our position is definitely coming to an end which is why the debt is important. I understand cutting spending can be dangerous in a recession. But we need to get our debt under control before we are no longer a world reserve currency. If we can control our debt before then things will go well for us. If we can’t we will come crashing down.
PS you have a nice blog here, very interesting.
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