Government Debt Levels over 90% and US GDP Growth

I think many people are now aware of the Reinhardt and Rogoff fiasco involving the spreadsheet error.

The idea that once government debt exceeds 90% of GDP, real output growth slows is at the heart of the whole Reinhardt and Rogoff business.

Although I cannot claim to have read Reinhardt and Rogoff’s work in detail, some thoughts strike me.

First, it is rather obvious that a lot of the data from nations where the debt-to-GDP ratio was higher than 90% come from years during and after World War II.

For example, the US had a government debt-to-GDP ratio over 90% from about 1943 to 1950.

You can see this below in the graph of US gross federal debt as a percent of GDP.



Obviously, the war years cannot count in any attempt to determine whether in peacetime, normal circumstances debt-to-GDP ratios over 90% slow growth.

But it is probably equally important to exclude certain years after 1945 as well. Why?

The reason is that the immediate post war years were highly irregular, because of the dismantling of wartime command economies and the conversion back to normal consumer-goods producing economies.

We can see this in the real GDP data for the US in these years:

Year | GNP* | Growth Rate
1939 | $1077.80 | 8.06%
1940 | $1170.80 | 8.62%
1941 | $1371.50 | 17.14%
1942 | $1623.50 | 18.37%
1943 | $1887.90 | 16.28%
1944 | $2040.20 | 8.067%
1945 | $2016.60 | -1.15%
1946 | $1798.20 | -10.83%
1947 | $1784.80 | -0.74%
1948 | $1864.80 | 4.48%
1949 | %1854.20 | -0.56%
1950 | $2016.50 | 8.75%
* Billions of chained 2005 Dollars
http://wikiposit.org/a?uid=FRED.GNPCA

It is curious that the annual GDP data show contractions in 1945, 1946, and 1947. But, as I noted above, this contraction was mostly the result of the dismantling of the US command economy and conversion of the wartime economy back into a peacetime economy producing consumer goods.

From its wartime peak in 1944 to 1947, GDP contracted by 12.7%. That was indeed a technical depression, but a depression sui generis mainly as wartime production ended.

In other words, data sets using these immediate post war years involving wartime conversion and technical depressions will grossly distort calculations of average growth rates.

Did Reinhardt and Rogoff correct and control their data in all countries concerned for this factor?

I really do not know, but I assume it is an important line of criticism.

Robert Murphy versus Paul Krugman on Government Debt

I see that Robert Murphy was interviewed by Judge Andrew Napolitano, on Paul Krugman’s view of government debt in the video below. While I found it interesting to see Murphy interviewed, I have a low opinion of his notion of government debt.



Some points:

(1) The interviewer’s hysterical reference to the explosion of debt (“50,000 every second” – which I am not sure is correct or not) is misleading: government debt might be rising, but so is GDP, and it is net government debt as a percentage of GDP that is a better measure of its burden.

(2) The notion of present generations “living at the expense of future generations” is utter nonsense. Any future generation cannot send real goods and services back in time, and our wealth today is dependent on the real goods and services produced, owned and consumed today, not in the future. The repayment of future government debt comes from three sources:

(i) Central bank open market operations. This does not even involve taxpayers’ money at all: money used to pay back debt in this way is simply created by central banks.

(ii) The government has the power to roll over much of its debt. As long as people keep purchasing the debt, there’s no problem.

(iii) The government’s repayment might be from current tax revenues. But, with expanding GDP, the government has access to tax receipts which grow over time, which effectively means that the burden of interest servicing and paying back debt falls as the population rises, GDP grows and tax revenues rise. Since the US has a progressive tax system the “individual” burden of government debt repayment differs markedly depending on income anyway.

The future “individual” burden of government debt is simply a redistribution of money at a future time point or period, and, if the money is spent, a redistribution of real goods, services or assets within the society at some future point in time: it cannot be a robbery by present generations of future wealth, because there is no way that future, real goods and services can be magically transported back in time to today.

(3) The only really serious burden associated with government debt is that part of the debt owed to foreigners (as Abba Lerner argued). But even here the US is in a unique position: the US dollar is the world’s reserve currency and US dollars can just as easily be used to buy other nation’s goods and services, rather than just US goods and assets.

(4) Underlying this obsession with government debt is the completely mistaken and fallacious analogy with private debt. In reality, government debt is different from private debt for these reasons:

(i) the government is the monopoly issuer of its own currency; no private individual can print money;

(ii) the government has the power to roll over much of its debt, unlike private individuals;

(iii) the government’s central bank has the power to control interest rates and bond yields, if necessary.

(iv) the government has access to tax receipts which grow over time, which can effectively mean that the cost of interest servicing on government debt falls as the population rises.

(5) If anything, it is the present generation and its incompetent unwillingness to restore strong GDP growth and high employment that robs future generations of a stronger economy and greater wealth, by permanent loss of the higher level of output and real assets we would enjoy if GDP was hitting its potential.

In summary, the tax burden on most individuals from repayment of future US government debt is likely to be small, given that the US has a progressive tax system, and most debt is rolled over. Other debt is bought back by the central bank – which does not even involve taxes at all.

Above all, the burden of taxes for future generations to repay debt or interest on debt would be much reduced if the right macroeconomic policies were restored.

In fact, the truth is that vicious deflationary policies and budget balancing is what will really rob future generations of wealth: it will rob them of the larger economy they would have had in the future from a larger base of GDP and capital stock today.

Above all, destroying present employment, income and leaving millions unemployed will probably prevent potential parents from having children that they might wish to have, because of present poor job prospects, low income, reduced growth and economic stagnation: thus the wages of austerity and budget balancing will prevent some members of future generations from even being born. That is the real crime against future generations.

I have to laugh every time I hear this “robbing future generations” balderdash. The extreme proponents of free market economics would rob potential members of future generations of their very existence.


Note

I highly recommend these classic articles by Abba Lerner on the issue of government debt:

Lerner, A. P. 1943. “Functional Finance and the Federal Debt,” Social Research 10: 38–51.

Lerner, A. P. 1947. “Money as a Creature of the State,” American Economic Review 37.2: 312–317.