{"id":417329,"date":"2010-03-11T15:12:00","date_gmt":"2010-03-11T20:12:00","guid":{"rendered":"tag:www.economist.com,21005327"},"modified":"2010-03-11T15:12:00","modified_gmt":"2010-03-11T20:12:00","slug":"how-much-is-too-much","status":"publish","type":"post","link":"https:\/\/mereja.media\/index\/417329","title":{"rendered":"How much is too much"},"content":{"rendered":"

ANDREW SCOTT mounts<\/a> an argument at Vox today which goes against much of the conventional wisdom among pundits\u2014sovereign debt in the wake of a crisis is no big deal. Mr Scott argues that debt levels tend to spike after a crisis, which will spark concern, but it makes much more sense to adjust back to previous levels of debt over the long-term, rather than trying to do it all at once (particularly if economic weakness persists). And, he says, major economies have done just that and been just fine in the past, even after hitting debt ratios much higher than those predicted for the immediate aftermath of the crisis:<\/p>\n

\n

In fact, although economics is quiet on the issue of what it means for debt to be too high it does tell us that in the face of large temporary shocks the optimal response is for debt to show large and long lasting swings. If bond markets are incomplete then we know from Barro (1979) and Aiyagari et al (2002) that debt should act as a buffer to help the government respond to shocks…In other words, in response to large short term shocks government debt should show decade long shifts…these optimal swings may even appear unsustainable for significant periods of time \u2013 even though, by design, they are not. Critically, debt is not \u201cmean reverting\u201d \u2013 it doesn\u2019t come back down to its previous level.<\/p>\n

The logic is simple. The UK and US government have the ability to borrow long term and the option to roll over their borrowing. Rather than abruptly raise taxation and cut government expenditure, fiscal policy should adjust over the long term. Fiscal adjustment in the short run is not enough to produce a surplus and so debt rises for a significant period.<\/p>\n

The potential magnitude and duration of these increases in debt can be substantial, but markets have financed much larger levels of debt than are predicted for the UK and US. The largest increases are related to war, but as Japan\u2019s recent experience shows this is not always the case. In the UK between 1918 and 1932 debt increased from 121% of GNP to 191%. It was not until 1960 that debt returned to its 1918 level.<\/p>\n<\/blockquote>\n

I am sympathetic to this view, but I think there is one glaring problem that makes his argument problematic. Here are two charts from the Congressional Budget Office’s long-term budget outlook<\/a>. First:<\/p>\n\n\n\n
\"\"<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

And second:<\/p>\n\n\n\n
\"\"<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

The first image shows spending and revenues, and you can clearly see that in the immediate aftermath of the crisis debt levels will be higher, but deficits will return to low levels (in practice, close to but just short of primary balance). If things ended there, then there would be no worry over debt. The adjustment back to lower debt ratios might take a while, but it would happen.<\/p>\n

But over the longer term, demographic shifts and rising health costs generate a different threat to budget sustainability. And as you can see in the lower image, the path of growth in the debt ratio proceeds onward and upward. In the Alternative-Fiscal Scenario (which incorporates likely policy changes) public debt is over 700%<\/em> of GDP. That, clearly, is not sustainable.<\/p>\n

It’s important to keep this in mind. The problem with the debt isn’t the spending or the deficits from recent years. It’s the fact that there is no time for adjustment in the wake of the crisis before the demographic debt bomb hits. And so something must be done.<\/p>\n

It’s still the case that something needn’t be done this year or next year. But by the end of the decade, something must be done.<\/p>\n","protected":false},"excerpt":{"rendered":"

ANDREW SCOTT mounts an argument at Vox today which goes against much of the conventional wisdom among pundits\u2014sovereign debt in the wake of a crisis is no big deal. Mr Scott argues that debt levels tend to spike after a crisis, which will spark concern, but it makes much more sense to adjust back to […]<\/p>\n","protected":false},"author":4534,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[7],"tags":[],"class_list":["post-417329","post","type-post","status-publish","format-standard","hentry","category-news"],"_links":{"self":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts\/417329","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/users\/4534"}],"replies":[{"embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/comments?post=417329"}],"version-history":[{"count":0,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/posts\/417329\/revisions"}],"wp:attachment":[{"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/media?parent=417329"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/categories?post=417329"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/mereja.media\/index\/wp-json\/wp\/v2\/tags?post=417329"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}