David B. Shemano asks:
>>... does PK give any indicattion of a debt level he thinks would be too high,
>>where he would recommend no more? If he was Goldilocks, what would be "just
>>right" and how are policymakers supposed to recognize that point? <<
raghu answers:
> ... There is no numerical debt level that is "just right" for all economies
> under all situations. But it is quite obvious that both extremes are absurd
> i.e. it is silly to argue either that the debt level always needs to be zero
> or that arbitrarily high debt levels are fine.<
A basic part of the answer is that the "best" level of government's
debt (to the public) would be defined relative to GDP, not in absolute
terms. Second, it would be defined relative to _potential_ GDP, since
that's a better indicator of the (maximum possible) tax base.
(Similarly, the impact of consumer and business indebtedness should be
measured relative to their incomes.) Since the US is operating
significantly below potential at this point (due to the recession),
the government's debt-to-potential ratio is significantly below its
debt-to-actual GDP ratio. (A first-guess of what potential is can be
seen by looking at the trend level of real GDP.)
Third, as any accountant will tell you, what matters is not the
government's debt but its net worth. A lot of Obama's stimulus
package, for example, raises not only the government's debt but its
assets, so that the much-ballyhooed negative effect of government
deficits is exagerrated. (Of course, those deficits also prevent the
recession from being worse than it is already. Deficit hawks seem to
want a deeper and/or longer recession than we see right now -- or
maybe they're ignorant or ideological and so don't see the impact of
following their wishes.)
As usual, the problem is political-economic, i.e., the institutional
lines between the government and the "private" sector. Much of the
government's deficits go to create assets not for the government but
for the private sector, just as many of the benefits of those assets
accrue not to the government but to corporations and households. (On
the latter, most of the benefits of running the legal system --
including the maintenance of private ownership rights -- accrue to
corporations and real people.) This means that even though government
borrowing might actually be keeping the country's net worth constant
or even raising it (all else equal), it can appear in the accounting
as a fall in government net worth.
R.J. Gordon's Macroeconomics textbook does not define government
solvency in terms of a specific ratio to (potential) GDP. Instead, if
the government debt is increasing faster than GDP, the government is
on the _road to_ insolvency. He states this rule in terms of the real
interest rate on government debt exceeding the growth of real GDP: the
idea is that if the real interest rate exceeds output growth, the
government debt is feeding on itself (due to borrowing being done to
make interest payments, which increases interest obligations, all else
equal). Of course, we have to recognize that government borrowing can
boost the rate of growth of real GDP. (The real interest rate on
government debt is really low these days, by the way.)
This is deeply unsatisfying since it doesn't say what the best ratio
is. It could be quite high. After all, the US enjoyed decades of
GDP-growth prosperity in the 1950s and 1960s even though it started
with a government debt/GDP ratio significantly above 100%. Among other
things, World War 2 era government borrowing meant that for the first
time in history, a lot of "middle class" people actually had financial
wealth (government bonds), which moderated the size of the post-WW2
recession.
My understanding is that the _true_ limit to the government debt/GDP
ratio is represented by the political attitudes of the rentiers (the
big owners of government bonds). If the ratio gets "too high" in their
subjective opinions, then they start shifting their portfolios to
other assets. That means that the U.S. Treasury has to pay a
significant risk premium (unlike nowadays), which means that the
relative role of interest payments in the government budget rises,
constraining expenditure increases and tax cuts. If the rentiers and
other rich folks also start avoiding taxes (and cheating on them) more
as their confidence in the government falls, that intensifies the
problem (as in Greece or Italy, e.g.)
We should remember that the U.S. is still the most powerful country in
the world along several dimensions. This means that the rentiers are
likely to keep their faith in the Treasury long after they've given up
on California and Greece. (T-bills are still the safest of havens.)
However, their political ideology encourages them to yell and scream
about government debt long before it's a problem.
--
Jim Devine
"Those who take the most from the table
Teach contentment.
Those for whom the taxes are destined
Demand sacrifice.
Those who eat their fill speak to the hungry
of wonderful times to come.
Those who lead the country into the abyss
Call ruling too difficult
For ordinary folk." – Bertolt Brecht.
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