How Much Does Debt Matter?
In our study “Growth in a Time of Debt,” we found relatively little association between public liabilities and growth for debt levels of less than 90 percent of GDP. But burdens above 90 percent are associated with 1 percent lower median growth.
Carmen M. Reinhart is a senior fellow at the Peterson Institute for International Economics in Washington and Kenneth S. Rogoff is a professor of economics at Harvard University. See full post here. HT: Greg Mankiw
This question has been debated among policy wonks for years. I’m not sure I can claim to know the precise answer. Advocates of spending argue we can carry the debt into the future when future generations will be better off than we are today. It’s not clear that is true. Tyler Cowen’s new book The Great Stagnation argues all the low-hanging fruit in our economy has been exhausted and growth will be slower from now on.
Moreover, I’m not sure it’s is ethical to force future generations to pay for benefits for today’s seniors. Our children and grandchildren were never given a say in the matter.
In addition, spending more on government than tax revenues causes government to consume an increasing proportion of the economy. Over time it crowds out productive uses for capital. I do want to drive on good roads and have police and fire protection. Yet, there are many bureaucrats performing tasks that don’t directly enhance my consumption. My primary goal (and most individuals goal) is to expand our consumption of the things we enjoy.
The authors do say that “Our main finding is that across both advanced countries and emerging markets, high debt/GDP levels (90 percent and above) are associated with notably lower growth outcomes.”
But reading that quote in context completely does away with any Pollyannaish thoughts about not having to worry about the effect of current debt levels on growth.
The authors catalog the ways in which developed countries took care of their debt through financial repression post-World War II. They note that “for many if not most advanced countries, dismissing debt concerns at this time is tantamount to ignoring the proverbial elephant in the room. So is pretending that no restructing will be necessary.”
A paragraph later they describe how goverments play the restructuring game and note that “markets for government bonds are increasingly populated by nonmarket players, calling into question what the information content of bond prices are relatively to their underlying risk profile–a common feature of financially repressed systems.”
In the discussion of debt and growth causality they note that “There is scant evidence to suggest that high debt has little impact on growth.” They conclude that countries seldom grow their way out of debts.
90% of GDP? Just wait. We’re getting there.