The public debt-to-GDP ratio is, perhaps, the most important measure used in discussions of the relative fiscal sustainability of nations. Nations with high levels of debt-to-GDP are viewed as having more serious fiscal problems than nations with lower levels. Nations having increasing ratios over time are viewed as becoming less fiscally sustainable, while those with decreasing ratios are viewed as more fiscally sustainable.
But is the public debt-to-GDP ratio really a valid measure of fiscal sustainability, or is it a measure that incorporates a neoliberal theoretical bias in its fundamental assumptions? In the United States the total value of public debt subject to the limit at any point is the total principal value of all the outstanding debt instruments sold by the Treasury Department. The GDP is the aggregate value of the production of goods and services in the United States within a particular period of time, adjusted for price changes.
So, the public debt is a variable measuring a cumulated stock, while GDP is a flow variable measuring economic activity within a particular period of time. Why compute a ratio of a cumulated stock to a flow within a circumscribed period of time?
Well, in this case of the debt-to-GDP ratio, neoliberal economists reason that the stock, the debt, can only be reduced if the government takes away part of the flow each year to repay a portion of the stock, the debt, leaving less of the flow to add financial savings to the private sector. After all, what other sources of government revenue are there exept taxation.
Comparing the debt to the GDP in a ratio, then, is thought to be relevant because GDP is viewed as the only place from which the government can get the financial savings it needs to pay off the debt. In this view, if a government has public debt, that creates a continuing burden of both principal and interest on the economy if it is to be paid down or paid off, a continuing burden of interest if it is to be held steady, and no immediate burden if the debt is to be increased.
On the other hand, increasing the debt over time, isn’t sustainable, unless the economy is growing at a faster rate than the debt, so sooner or later, there will be a day of reckoning. The government will have to stop increasing the public debt, and depending on other factors, may even have to “bite the bullet” and pay it down or off.
Is this reasoning behind the debt-to-GDP ratio correct? Must the Government “fund” its repayment of debt from current economic activity and in doing so, burden that activity? If so, then the debt-to-GDP ratio is a measure of fiscal sustainability, and this ratio is important to measure and use as a guide to fiscal policy. If not, then perhaps there’s a need for other measures that better represent government’s ability to repay its debt, or at least to avoid solvency crises.
I think current economic activity isn’t the only source for government debt repayment, even though it is one possible source of it. Government also has assets that may be used to repay debt, as well as income from taxes. So, a ratio that would be conceptually more valid than debt-to-GDP as a measure of ability to pay, is the ratio of public debt to financial assets available to the government.
The US government has many valuable financial assets, but among them the most valuable is its constitutional authority to create money whose financial value it can specify at will (which under present legislation is delegated to the Federal Reserve System and its member banks, and to the Treasury), provided only that the United States retains its present monetary regime of a non-convertible fiat currency, with a floating exchange rate, and no debts owed in any foreign currency. Now, how much is that asset worth, year after year, compared to whatever level of debt is in question?
What is the value of the federal debt to federal financial assets (the federal financial incapability) ratio, when the denominator of that ratio, is, in effect, infinity? That value always = zero, whatever the level of debt may be at any point.
So, there can never be any diminution or increase in the federal financial incapability ratio of a fiat sovereign government like the US government to repay its debt instruments, regardless of how small or large the principal value of those debt instruments is. Whether that value is $50 million, or $50 quadrillion, the value of the federal financial incapability ratio is still zero.
Not all nations can claim a zero financial incapability ratio. If a nation is not a fiat sovereign, then the value of its incapability ratio will be greater than zero, and the greater its government debt, the lesser its Government assets, and the lower its economic activity, the greater its financial incapability.
If it is a fiat sovereign, however, the value of its financial incapability will never be greater than zero. In other words, it has no financial incapability at all. This is a lesson that neoliberals ought, finally, to learn.
Most economists would disagree and claim that the ration of national debt to GDP does not need to be zero and provided that thye amount of interest being paid for this loan is not excessive, its OK for this burden to be carried, by the taxpayer of course!
I find that the rate of interest is the devil here. A national bond which has just been redeemed after paying at a high interest rate would be renewed (or the sum re-borrowed) by the government, at a low rate of interest today. But if the total debt is 5 times what it was 30 years ago when the bond was first sold, then the penalty to the tax payer is considerably worse than before, even at low interest rates. Since the money being loaned and the value of the bond will shrink at the low interest rate after the rest of the dividend-earning shares or loans begin to recover, it is going to mean that these bonds will loose their value and can only be attractive and be sold for a shorter time period than the 30 years previously taken.
So in practice, there is some kind of limit as to how big the ratio can comfortably reach and I find that it is less that one or even less than a half, when there is a warning of good time ahead. Beware US!
Macrocompression,
My understanding of #MMT is that in any country with a fiat currency it’s the three sectors that have to balance,” private (domestic), foreign, and public. See Stephanie Kelton’s, extremely accessible 49-minute video “Fiscal Space and Finanacial Instability: A Differential Analysis.” http://www.fields.utoronto.ca/video-archive/2013/11/221-2524
Steve Keen made essentially the same points in Forbes, “Beware Politicians Bringing Household Analogies.”
http://www.forbes.com/sites/stevekeen/2015/01/14/beware-of-politicians-bearing-household-analogies-3/
Likewise my understanding from #MMT is that demand-pull inflation and price stability are the real constraints on the federal deficit.
When it’s about a few trillion dollars in federal investment in the real economy, health care, education, and infrastructure, the media gets nervous about inflation.
When it’s about hundreds of trillions in Quantitative Easing to “socialize” Wall Street’s risks onto the taxpayers, all those concerns about inflation almost disappear.
As far as I know, most of the derivative exposure is in currency and interest rate swaps.
JPMorgan Chase
Total Assets: $2,476,986,000,000 (about 2.5 trillion dollars)
Total Exposure To Derivatives: $67,951,190,000,000 (more than 67 trillion dollars)
Citibank
Total Assets: $1,894,736,000,000 (almost 1.9 trillion dollars)
Total Exposure To Derivatives: $59,944,502,000,000 (nearly 60 trillion dollars)
Goldman Sachs
Total Assets: $915,705,000,000 (less than a trillion dollars)
Total Exposure To Derivatives: $54,564,516,000,000 (more than 54 trillion dollars)
Bank Of America
Total Assets: $2,152,533,000,000 (a bit more than 2.1 trillion dollars)
Total Exposure To Derivatives: $54,457,605,000,000 (more than 54 trillion dollars)
Morgan Stanley
Total Assets: $831,381,000,000 (less than a trillion dollars)
Total Exposure To Derivatives: $44,946,153,000,000 (more than 44 trillion dollars)
http://www.zerohedge.com/news/2014-09-25/5-us-banks-each-have-more-40-trillion-dollars-exposure-derivativeshttp://
Virtually none of this is “trickling down” into the “real economy.”
“The Wall Street bonus pool for last year is roughly double the total earnings of all Americans who work full time at the federal minimum wage.”
“…Let’s start with the Wall Street bonuses. The New York State Comptroller reported on Wednesday that the size of the bonus pool paid to securities industries employees in New York City was $28.5 billion. Dividing this total among 167,800 workers yields an average bonus of $172,860, which seems plausible enough. For sure, some received much, much bigger bonuses, and many received nothing.
What about the total earnings of full-time workers at the federal minimum wage? The Bureau of Labor Statistics reports that there are 1.03 million full-time workers paid an hourly wage of $7.25 or less. These people tend to work around 40 hours a week on average. If they all earn $7.25 per hour and work 50 weeks per year, the total earnings of this group come to nearly $15 billion. Ms. Anderson, whose report usefully shows all her work, prefers an estimate of 37 hours per week — which looks too low to me based on other data — and 52 weeks per year, so after rounding, she gets to a total of $14 billion.
…”
http://www.nytimes.com/2015/03/14/upshot/wall-street-bonuses-vs-total-earnings-of-full-time-minimum-wage-workers.html?abt=0002&abg=1http://
As you know, to put those hundreds of trillions into some perspective, the World Bank estimated US GDP (Gross Domestic Product) in 2013 at around $16.77 trillion. http://data.worldbank.org/country/united-stateshttp:// Government estimates of $6 trillion spent in Iraq and Afghanistan are probably low. http://www.globalresearch.ca/us-wars-in-afghanistan-iraq-to-cost-6-trillion/5350789http:// Social Security’s Trust Fund is around $2.3 trillion. http://crfb.org/blogs/general-revenue-social-security-trust-funds
What can I say? Most economists are wrong! The post shows why the debt level doesn’t matter and also why the interest that has to be paid doesn’t matter for a fiat sovereign like the US. Your reply doesn’t cut against the points made in the post. Most importantly, if the fiat sovereign uses it currency/reserve creation authority to spend without accompanying that spending with debt issuance, it won’t matter whether it can sell 30 year bonds or not.
Terrific post, thank you.
Thank you!
The stock-flow inconsistency is true, and it is there on purpose in order to measure something that is not dependent on the current interest rate, which can fluctuate wildly according to the whims of the Fed. The important ratio, if there is one, is the ratio of interest payments to total spending. At a constant interest rate, and some agreed level of total government spending as a proportion of GDP (determined by the political process), then the level of debt allowed is determined. It’s just math.
But given a political constraint on spending as a % of GDP, and a non-zero interest rate, there is a level of debt at which interest expense will consume the entire budget. At levels well below that, it will start to limit the policy space for other public purpose spending.
If the society is willing to have interest expense, and thus public spending, at much higher proportions of GDP, even approaching 100%, then it’s true there is no mathematical limit on the amount of debt, regardless of the interest rate.
But it’s also true that a monetary sovereign has no need for interest-bearing debt at all. We’re doing it wrong.
Yes, I often make this point, as I think you know. See: http://amzn.to/Z7kG5q