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Debt Drag: Krugman, Konczal Miss the Point
Posted By Salim Furth, Ph.D On March 7, 2013 @ 12:00 pm In Economics | Comments Disabled
On their respective blogs, economists Mike Konczal  and Paul Krugman  criticize the widely cited finding that a nation’s debt above 90 percent of its gross domestic product (GDP) slows economic growth. They presume that the limitations of one study  by Carmen Reinhart and Kenneth Rogoff  mean that its warning can be ignored.
But Konczal and Krugman are ignoring most of the economic literature on the topic of debt drag. Using different data sets and different statistical techniques, several other economists have reached substantially the same conclusion as Reinhart and Rogoff.
Two economists at the International Monetary Fund  studied the link between debt and growth across countries and found that higher debt is associated with lower future growth, especially when debt passes the 90 percent threshold. They discuss the difficulty of proving causation, and they use half a dozen different econometric techniques to show that their results do not depend on a particular approach. They conclude that governments at high debt levels, including the U.S., need to “not just stabilize public debts but to place them on a downward trajectory.”
A group of economists at the Bank for International Settlements  (BIS) used different methods to investigate the interplay of government, household, and corporate debt. They look for “threshold effects”—a cutoff point above which debt becomes damaging to growth. They find that the cutoff for government debt is in the area of 84 to 96 percent of GDP. At debt levels below 84 percent, the BIS team finds that government debt may have a negative effect on future growth, but they cannot be certain from the data.
In a narrower investigation, analysts at the European Central Bank  tackle the question of debt drag in eurozone countries and try to identify at what level government debt becomes distinctly harmful to economic growth. Like the other authors, they are careful to address the question of causation. They use an innovative technical insight to lend credence to the idea that high debt causes low growth. They use several approaches, all of which find a cutoff between 90 percent and 100 percent of GDP. According to the broad measure of debt they use, the U.S. is already above 100 percent of GDP  in debt.
The warning against debt drag is not merely theoretical. The U.S. is presently lurching toward or into the danger zones identified by all four teams of economists above. And even if the economy recovers, the current trajectory is grim. Indeed, Bob Hall  of Stanford University argues that federal deficits since 2007 have been systematically higher than over the previous 50 years, and economic conditions are not the only factors to blame. He concludes that on its current trajectory, debt will continue “to grow to completely unsustainable levels.”
Ignoring the warnings of economic science will not make them go away. As a Nobel Prize winner once noted , “[P]rofessional economists, at least, should know better.”
Article printed from The Foundry: Conservative Policy News Blog from The Heritage Foundation: http://blog.heritage.org
URL to article: http://blog.heritage.org/2013/03/07/debt-drag-krugman-konczal-miss-the-point/
URLs in this post:
 Image: http://blog.heritage.org/wp-content/uploads/krugman_130307.jpg
 Mike Konczal: http://www.nextnewdeal.net/rortybomb/no-90-percent-debt-threshold-hasnt-been-proven
 Paul Krugman: http://krugman.blogs.nytimes.com/2013/02/27/another-attack-of-the-90-percent-zombie/
 one study: http://www.economics.harvard.edu/files/faculty/51_Growth_in_Time_Debt_aer.pdf
 Carmen Reinhart and Kenneth Rogoff: http://www.reinhartandrogoff.com/
 Two economists at the International Monetary Fund: http://www.imf.org/external/pubs/ft/wp/2010/wp10174.pdf
 group of economists at the Bank for International Settlements: http://www.bis.org/publ/work352.pdf
 analysts at the European Central Bank: http://www.ecb.int/pub/pdf/scpwps/ecbwp1237.pdf
 100 percent of GDP: http://www.imf.org/external/pubs/ft/scr/2012/cr12213.pdf
 Bob Hall: http://www.stanford.edu/~rehall/Fiscal130204
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