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Rethinking Debt
Washington refuses to understand that debt can be an essential tool for economic growth. Can we overcome this irrational and destructive fear?
There’s another timing point here, made forcefully in recent commentaries by Yale economist Robert Shiller. Economists and official budget scorekeepers like the Congressional Budget Office judge the sustainability of budget plans by whether the debt-to-GDP ratio is rising or falling. Shiller points out, however, that this conflates an annual measure—GDP—with a debt measure that is decidedly non-annual. We don’t have to refinance government debt all at once in a given year. For example, it might seem intuitive that if public debt were 100 percent of GDP, we’d be insolvent, but of course that’s not the case. During World War II, that ratio exceeded 100 percent, and for good reason. A decade later, it was 52 percent.
Again, timing matters. Temporary deficits, say, to offset a downturn, make a lot more sense than permanent, or structural, deficits in a recovery (“structural” in this context means that even with a healthy economy, the deficit would persist). Seemingly large debt burdens in a given year can be dealt with over the course of many years. But while Keynesian stimulus (such as the Recovery Act) is temporary by definition, the aging of the population and the rise of health care costs are not. The problem, once again, is not borrowing—it never is. It’s what are you borrowing for, how long you will need to pay for it, and how you are going to pay it back.
Cost of borrowing: As I write this sentence, five-year Treasury bills carry an interest rate of about 1 percent, a near historic low. Why so low? Because the economy is so weak, inflationary pressures are low, stocks are volatile, Europe is a mess—all of which make hyper-safe securities like T-bills a highly desirable investment. That’s actually an important and salutary dynamic in an advanced economy with mature capital markets. It signals that government should borrow and deficit-spend on temporary measures to stimulate growth.
At such low rates and with so much economic slack, fiscal policy needs to focus on increasing the denominator of the debt-to-GDP measure, not lowering the numerator. If we borrowed 1 percent of GDP at the current interest rates to make investments in the economy, and assumed a (conservative) multiplier of 1.2 (meaning every dollar spent creates $1.20 of growth), debt-to-GDP would, under plausible assumptions, barely budge as the boost to growth would at least partially offset the increment to the annual deficit. And a lot more people could get back to work.
The point is that when borrowing costs are low because of a recession and all the slack it causes—which is precisely what we’ve seen in recent months—that’s an important signal to the government to engage in temporary fiscal expansion. To do so has the benefit of reducing unemployment and boosting growth at comparatively little cost to the federal budget. To fail to respond to this signal is to consign millions to joblessness under the false pretense of fiscal rectitude.
Little distinction in magnitudes: There’s a difference between “small” and “large” federal budget deficits. But when all debt is evil, such distinctions get lost. The concept of “primary” balance is important here. A deficit that is in primary balance is small enough that the government is raising adequate revenue to pay its operating budget—that is, everything it spends money on except the interest on the debt. Once the budget deficit is at least in primary balance, the debt-to-GDP ratio stabilizes—it stops growing. Deficits below about 3 percent of GDP right now would constitute primary balance. Indeed, the budget plan recently released by President Obama gets deficits down to below 3 percent by 2014 through the rest of the decade. Sure enough, the debt-to-GDP ratio peaks in 2013 at 76.9 percent, then falls to 73 percent by 2021.
Again, the point is that the failure to make this distinction contributes to austerity frenzy, such as the pervasive calls for a balanced budget amendment and aggressive budget cuts. When the economy is on a solid expansion trajectory, we want the deficit-to-GDP ratio shrinking each year, but it doesn’t have to go to zero or surplus right away. Primary balance is a fine intermediate goal.
“Tighten our belts”—an awful analogy: Beware simple, folksy metaphors that emanate wisdom but convey exactly the wrong message. My candidate for the most destructive of all is that old saw about deficit reduction: “Hey, families have to tighten their belts when things get tough…government should too.” President Obama himself has made this mistake.
Sounds right, but it’s totally backwards. When the economy stumbles and family income stumbles with it, then sure, families have to tighten up. But this is precisely why government has to loosen its belt. That’s the whole point of countercyclical policy: When the private sector is contracting, the public sector temporarily expands, and vice versa. The analogy is wrong on both ends: When the private sector is humming along, and working families can maybe loosen their belts a bit, that’s when the government needs to tighten its belt.
Who owns the debt?: It’s always important to remember that one person’s debt is another person’s asset. When it comes to the budget deficit, while we owe about half of it to foreign holders of Treasuries (China and Japan being the most prominent lenders), we owe the other half to ourselves. That doesn’t mean we can afford to ignore unsustainable borrowing. But from a macroeconomic perspective, it doesn’t necessarily hurt the economy to borrow from ourselves to invest in productivity-enhancing initiatives that increase the future wealth of our progeny.
Ever hear of the agency problem of economics? Well, the government has it. In spades. So more debt to an incompetent government, who engineered the crisis, and to its venal and equally incompetent campaign contributing revolving door bank cronies, will do nothing whatsoever. Except maybe land you a cushy sinecure, you damn proto-wannabe bureaucrat.
Dec 13, 2011, 2:53 PMMizrahi -- your comments (well, actually, one posted twice) are quite substantive and important to a resolution to our problems.
(Sadly, the vitriol almost sent me running before I took the time to see what you're trying to say.)
It would be insane to keep expanding a government with a poor track record. At some point, drastic measures need be taken to change the way government operates.
We hope we can accomplish this without resorting to anarchy while waiting for a new government to evolve.
regards, common man bob
Dec 13, 2011, 5:42 PMI would add Evsey Domar to the wise troika. He formally and clinically defined debt sustainability.
Dec 14, 2011, 7:14 AMI don't really see any validation here of your claim that debt is an essential tool for growth. You say "Borrowing from the future to invest in the present is one way to improve that future." Well if that's the measure for essentialness, then I guess saving for future spending would also qualify. What makes spending now better than not spending now? If we could claim that the spending bought us something that matters, that would help. Putting people to work would be nice, but if you want the economy to function those people need to be creating value. This essay appears to me to be a very long-winded way of screaming "Breathe!" at a dying patient.
Dec 14, 2011, 3:50 PMMizrahi never read Irving Fisher's accurate description of a debt/deflation cycle Jared, so you're wasting your talent on him.
Plus Mizrah's favorite political party, I'm thinking, invented crony capitalism a century ago, and in 2002 eliminated paygo so they could run up the debt bill in good times. Madness.
Run the bill up. They're paying us to take their money. Time to invest instead of dropping bombs on Muslims, or paying oil companies not to drill.
Dec 14, 2011, 3:55 PMI think Modern Monetary Theory economists like Warren Mosler make a better case against debt and deficit panic by pointing out the fundamental fact that government debt = private sector savings to the penny.
Treasury securities are in essence savings accounts and "paying off debt" when they mature is as simple and pain free as moving balances from these savings accounts to checking (reserve) accounts at the Fed.
Dec 15, 2011, 10:43 AMLots of good points in this article... But it's worth pointing out that it's ridiculous to increase the level of debt as a substitute for our generation's unwillingness (esp. that of our generation's rich) to pay their way. Taxes in the US are at historic lows and that's the main reason we have deficits and a national debt.
Secondly, public spending in a recession makes sense in theory... but given the way that the US economy has changed in relation to the world (given our status as a huge importer), we should think twice before just throwing govt money at growing our GDP... even in a recession. The multipliers now appear in China even more than here. It's time to think differently (at least for us to think differently). We should be targeting govt investment to create sustainable jobs and exports... like Europe, Japan and China. We shouldn't be funding "shovel ready" jobs that disappear with govt funding.
The folks setting policy, including Bernstein, need to get smarter. Flying our economy according to the old flight plans "ain't cutting it. "
Dec 15, 2011, 4:42 PMAnd btw, I'd say the govt bailout of Chrysler is a prime example of useful govt investment. Investing in green tech would be great too... but in light of a recent "scandal", we have to expect that' we'll sometimes pick losers as well as winners.
Dec 15, 2011, 4:51 PMTo say government engineered the economic crisis is not reality based thinking. It is fantasy. Did government create CDOs (collateralized debt obligations) that purposefully confused investors and cheated them? Did government gamble with Credit Default Swaps which still hang like death over credit markets? No. The government, shackled by ideology based thinkers in the Bush Administration and Congress, tied the hands of regulators that were prevented from doing the jobs that they were legally obligated to pursue. Republicans caused the economic crisis, then blamed in on government because government didn't let "bad firms fail." What a laugh. That was GW Bush and Wall Street's policy, pushed heavily by Republicans. That thinking is the cause of the economic crisis, not the government whose proper function is regulating the abuses of the private sector. It's time to let government do the regulatory job that it, and only it, can do.
Dec 15, 2011, 8:04 PM"A precious few economists warned of the housing bubble, which was the root cause of the recession."
This is oversimplification to the Nth degree. The "bubble" was not a bubble until two triggers:
1. Job loss...can't pay the mortgage without a job, duh!
2. Effective default of the credit insurance sector...AIG, for example and the incorrectly rating junk derivatives as AAA with no reserves to cover real mortgage defaults. Buffett called them financial weapons of mass destruction for a good reason.
Excellent essay. I am frustrated by President Obama's occasional comments that signal some level of agreement with the "We must shrink government and deficits immediately crowd." While these comments play well the political analysts who think they know what independents want (smaller government is their latest guess) these comments inadvertently help to spread harmful misunderstanding regarding when and how much the federal government needs to borrow. As the author has stated the US government should be paying down debt during good times and increasing borrowing to create missing demand during a slack economy. This isn't rocket science. It's Economics 101 in college.
Dec 17, 2011, 8:30 PM... timing the market? Perhaps I can sell you some stock?
Dec 19, 2011, 1:25 PMThe problem about debts is, that they make you dependent on the loaner. Means, if the state borrows money from banks you have to do what banks want you to do. And this means that politics in made by banks and not by the government and the people of a nation.
If America wants to be a free nation, they have to be free of debts first of all.
Though, bankers will tell you the opposite, for obvious reasons.
Feb 1, 2012, 3:07 PMPeople like that below me really discredit their own opinion with their anger, and also apparently didnt read the whole piece and completely deny the foundation of historical knowledge that support the basic ideas of public spending. Cronyism in our capitalism and an over concentration on incumbant economic power is a real problem, and legitimate concern, but the fear based reactionary criticism of strongly supported ideas is out of focus, a true rejection of all relevant information.
Feb 3, 2012, 10:46 PMPeople like that below me really discredit their own opinion with their anger, and also apparently didnt read the whole piece and completely deny the foundation of historical knowledge that support the basic ideas of public spending. Cronyism in our capitalism and an over concentration on incumbant economic power is a real problem, and legitimate concern, but the fear based reactionary criticism of strongly supported ideas is out of focus, a true rejection of all relevant information.
Feb 3, 2012, 10:48 PMPost a Comment
Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities and was formerly chief economist to Vice President Joe Biden.
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