Enamored with debt numerology
The Washington Post’s editorial board was quick to rebuke President Obama’s recommendations to the Select Joint Committee on Deficit Reduction for not going far enough:
“The president’s plan would leave the debt at an unhealthy 73 percent of gross domestic product. The Simpson-Bowles plan would reduce that number to 65 percent, a still high but far less troubling level.”
What is driving this debt target of 65 percent, or 60 percent for that matter? Numerology comes to mind, as does austerity for austerity’s sake.
Let’s be clear – addressing the jobs-crisis is the most important near-term necessity – and if doing so drives the debt to greater than 60, 65 or 73 percent of GDP (or any other magical number), that’s fine.
Over the medium-term, stabilizing the trajectory for the debt-to-GDP ratio is a reasonable goal. But, there is no evidence at all that stabilizing it at 73 percent is more dangerous or troubling than any other number. (Click here for wonky footnote).
Reducing public debt-to-GDP by another 8 percentage points in 2021 would reduce annual debt service by roughly 0.3 percentage points of GDP. On the other hand, the steps required to achieve this fiscal contraction will also reduce economic activity in an economy that is years and years away from full employment. In fact, the economic activity suppressed by a fiscal contraction needed to achieve the Post‘s totally arbitrary target by 2021 would see foregone tax revenues and increased safety spending that would surely lead to a more than 0.3 percent of GDP deterioration in the budget. And millions of job-years lost to unemployment.
Our long-term budget blueprint Investing in America’s Economy, as adapted for the Peter G. Peterson Foundation’s Solutions Initiative, stabilized debt-to-GDP at 77 percent in 2021 and 82 percent by 2035. We thought investing $2.5 trillion over the next decade to put America back to work building a more competitive economy was more important than embracing austerity and targeting an arbitrary debt level. And again, there is no serious evidence that can be brought to bear suggesting that we’re wrong.
Footnote: Much of the policy rationale for targeting a lower debt ratio comes from Carmen Reinhart and Kenneth Rogoff’s paper Growth in a Time of Debt, which argues that economic growth becomes hindered when government debt exceeds 90 percent of GDP, but this research fails to identify causality. Slow growth can just as easily account for higher debt accumulation. And as my colleagues John Irons and Josh Bivens explain in this paper, the Reinhart and Rogoff results are inapplicable to the United States because the data sample is entirely sensitive to the post-war demobilization, in which economic contraction was driven by large spending cuts, not contemporaneously high debt. Stripping out 1945 and 1946 from the sample yields 2.8 percent average growth for all other years in which government debt exceeds 90 percent of GDP. (Note: their specification uses gross government debt rather than the more applicable measure—debt held by the public, which dictates market interest rates and any crowding out effects—so the 90 percent threshold isn’t an apples-to-apples comparison with the public debt levels discussed above.)
Debt hysteria yanked the national policy focus away from the economic recovery, toward the counterproductive debt ceiling debacle. The policy debate is finally pivoting back to job creation, but it should never have strayed, as is demonstrated by the abysmal 0.7 percent growth in the first half of this year and recent jobs reports. When it is time to think about longer-run fiscal problems, solutions should be informed by actual evidence, not hand-waving about debt targets that sound “troubling” for some ill-defined reason.
And how is the austerity camp faring in Europe? This week’s leader in The Economist finally proclaimed austerity a massive failure: “Sharply cutting budget deficits has been the priority—hence the tax rises and spending cuts. But this collectively huge fiscal contraction is self-defeating. By driving enfeebled countries into recession it only increases worries about both government debts and European banks.” This sounds a lot like Reinhart and Rogoff’s causality reversed. Whoops.