Our empirical research ( Growth in a Time of Debt) on the history of financial crises and the relationship between growth and public liabilities shows that burdens above 90% are associated with 1% lower median growth – and the United States’ debt level is currently hovering around 90% on a gross basis and 60% netting out assets.
Politicians like to argue that their country will expand its way out of debt but our historical research suggests that growth alone is rarely enough to achieve that…[given] the debt levels we are experiencing today…[As such,] we need to be cautious about surrendering to the “this-time-is-different” syndrome and decreeing that surging government debt isn’t as significant a problem in the present as it was in the past. [Let us explain further.] Words: 1175
So say Carmen M. Reinhart and Kenneth S. Rogoff in edited excerpts from an article* written for Bloomberg News (bloomberg.com) which Lorimer Wilson, editor of www.munKNEE.com (It’s all about Money!), has further edited ([ ]), abridged (…) and reformatted below for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.
Reinhart and Rogoff go on to say:
Are Low Interest Rates the Answer?
There is a growing perception that today’s low interest rates for the debt of advanced economies offer a compelling reason to begin another round of massive fiscal stimulus…[While] we agree that governments must exercise caution in gradually reducing crisis-response spending, [however,] we think it would be folly to take comfort in today’s low borrowing costs, much less to interpret them as an “all clear” signal for a further explosion of debt… Market interest rates can change like the weather while debt levels, by contrast, can’t be brought down quickly. [Furthermore,] interest rates seldom indicate problems long in advance. In fact, we should probably be particularly concerned today because a growing share of advanced-country debt is held by official creditors whose current willingness to forgo short-term returns doesn’t guarantee there will be a captive audience for debt in perpetuity.
[While] we expect to see more than one member of the Organization for Economic Co-operation and Development default or restructure their debt before the European crisis is resolved, [however,] that isn’t the greatest threat to most advanced economies. The biggest risk is that debt will accumulate until the overhang weighs on growth.
When Does Indebtedness Become Problematic?
In our study – based on a data set of public debt covering 44 countries for up to 200 years… incorporating more than 3,700 observations spanning a wide range of political and historical circumstances, legal structures and monetary regimes – we found…[that] debt levels above 90% of GDP are associated with 1% lower median growth.
We aren’t suggesting there is a bright red line at 90%; our results don’t imply that 89% is a safe debt level, or that 91% is necessarily catastrophic… However, our study of crises shows that public obligations are often hidden and significantly larger than official figures suggest. In addition, off-balance sheet guarantees and other creative accounting devices make it even harder to assess the true nature of a country’s debt until a crisis forces everything out into the open. (Just think of the giant U.S. mortgage lenders Fannie Mae and Freddie Mac, whose debt was never officially guaranteed before the 2008 meltdown.)
How Broad a Measure of Public Debt is Included?
Our empirical work concentrates on central-government obligations because state and local data are so limited across time and countries, and government guarantees, as noted, are difficult to quantify over time (until we developed our data set, no long-dated cross-country information on central government debt existed) but state and local debt are important because they so frequently trigger federal government bailouts in a crisis. Official figures for state debts don’t include chronic late payments (arrears), which are substantial in Illinois and California, for example, and it isn’t unusual for governments to absorb large chunks of troubled private debt in a crisis.
Any discussion of public liabilities should [also] take into account the demographic challenges across the industrialized world. Our 90% threshold is largely based on earlier periods when old-age pensions and health-care costs hadn’t grown to anything near the size they are today. Surely this makes the burden of debt greater.
Will Higher Inflation Solve the Problem?
There is a growing sense that inflation is the end-game to debt buildups. For emerging markets that has often been the case, but for advanced economies, the historical correlation is weaker. Part of the reason for this apparent paradox may be that, especially after the Second World War, many governments enacted policies that amounted to heavy financial repression, including interest-rate ceilings and non-market debt placement.
Low statutory interest rates allowed governments to reduce real debt burdens through moderate inflation over a sustained period. Of course, this time could be different, and we shouldn’t entirely dismiss the possibility of elevated inflation as the antidote to debt.
Why is a Debt-to-GDP Ratio of 90% of Major Concern?
Those who remain unconvinced that rising debt levels pose a risk to growth should ask themselves why, historically, levels of debt of more than 90% of GDP are relatively rare and those exceeding 120% are extremely rare. Is it because:
- generations of politicians failed to realize that they could have kept spending without risk or, more likely, because
- at some point, even advanced economies hit a ceiling where the pressure of rising borrowing costs forces policymakers to increase tax rates and cut government spending, sometimes precipitously, and sometimes in conjunction with inflation and financial repression (which is also a tax)?
The relationship between growth, inflation and debt, no doubt, merits further study; it is a question that cannot be settled with mere rhetoric, no matter how superficially convincing. In the meantime, historical experience and early examination of new data suggest:
We need to be cautious about surrendering to “this-time-is-different” syndrome and decreeing that surging government debt isn’t as significant a problem in the present as it was in the past.
*http://business.financialpost.com/2011/07/14/debt-eventually-suffocates-growth/ (Carmen M. Reinhart is a senior fellow at the Peterson Institute for International Economics in Washington. Kenneth S. Rogoff is a professor of economics at Harvard University. They are co-authors of This Time is Different: Eight Centuries of Financial Folly.)
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