Friday, May 8, 2015

The debt effect

What does debt do to an economy? Salim Furth writes:

Economic scholars have recently shown how high government debt has a negative effect on long-term economic growth.

Government debt crowds out private investment, slowing the growth of gross domestic product (GDP) and wages. The consensus is that “debt drag” gets worse as debt rises. Like piling bricks on a sled, each new annual deficit adds to the weight of the existing debt.


When savings are invested in government bonds, they cannot also be invested in productive capital. Since capital augments labor productivity and wages, lower capital accumulation leads to lower wages.

It’s intuitive. Debt is backward-looking. Debt divests the future. Debt is paying more money now for something that can be bought for less in the past.

After a quick and dirty analysis of debt-to-GDP ratio and GDP growth, I found the three most prosperous decades since World War II (’50s, ’60s, and ’90s) occurred as the debt-to-GDP ratio was shrinking. The worst decade for GDP growth, the 2000s, occurred during a debt spike. Further statistical analysis of the post-war era shows 4-year cumulative GDP growth is impacted .24 percent per 1 percent change in debt-to-GDP, on average. The top 7 4-year periods for GDP growth averaged 22.1 percent growth and 17.1 percent shrinkage in debt-to-GDP. The worst 6 periods averaged 2.7 percent GDP growth and 17.4 percent growth in debt-to-GDP.

U.S. GDP has been averaging 2.2 percent annual growth since the Great Recession. Insofar as that’s bad, Keynesians like Paul Krugman blame “austerity” for sapping demand from the economy. While Republican budget cuts have reduced the yearly budget deficit from 13 digits to 12, the government is nowhere close to the real austerity policies in effect during past boom years, when America ran year-over-year budget surpluses.

At any rate, I think most of the post-recession growth is due to bloated stock evaluations pumped up by the Federal Reserve. Forget the unemployment rate. The unemployment rate is good only propaganda. Labor participation is down, full-time jobs are down, wages are down. They called the period between 1933 and 1937 a recovery, too.

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