FDR would not fall into the trap economists like Krugman and Baker have
Posted by Charles II on August 27, 2011
Eswar Prasad and Mengjie Ding, Brookings:
Our analysis paints a sobering picture of worsening public debt dynamics and a sharply rising debt burden in advanced economies. These rising debt levels combined with heightened concerns about fiscal solvency now constitute a major threat to global financial stability.
What is a reasonable debt burden? We routinely accept personal debt burdens two, three, or four times the size of our annual income when we buy a house. In college, we may accept a debt burden ten or twenty times our income. In war, the US comfortably carried a debt burden over 100% of GDP. And Japan currently has a debt of 200% of GDP (figures for all countries in 2007, 2011, and 2016 are here). At the moment, the US is in the middle of the pack, and expected to stay there.
But there is a reason to be concerned about debt levels, both in the US and in other countries. Paying interest on the debt subtracts from productive investment that government can engage in. Interest on the US debt in 2010 was over $413B. We are already at that level in 2011 with two months to go. If interest rates were to rise to 5% on all debt, its average level, we would be paying $730B. When one considers that the entire stimulus devoted to jobs (federal contracts, grants and loans) was $275B, the problem should be obvious: we are spending too much on past wars, pork, and tax giveaways versus what we spend on creating jobs.
Many liberal economists, people like Dean Baker [added: a minor example is here and another here. I will replace thesse with a better link if I can find one] and Paul Krugman say, in effect, Just spend! The consequences of the output gap created by mass unemployment are larger than the interest payments! They have a point. With interest rates this low, borrowing looks attractive. [Added: And, as the output gap is closed, revenue collections increase…assuming we’re collecting the taxes.] But interest costs are already way too high. They represent a burden roughly equal to 15% of the entire 2007 budget. We can expect them to rise to 25% or more if the right-wing has its way. They are, in short, socialism for the very wealthy extracted from the society as a whole in the form of benefit cuts and poorer governance.
The game plan of the Republicans is transparent. Increase the debt to high levels, create a panic about the debt that will lead to interest rates rising to very high levels, and then sit back and clip coupons. It’s an insane strategy, one that will lead to a further decline in the dollar and in the US as a nation. But it worked for them in the 1980s, and they clearly intend to try it again.
FDR would never fall into this kind of trap. Democrats have to demand responsible budgeting–including higher taxes–in order to generate revenue for jobs. If they fail in this, falling either into reckless budget cuts without tax rises or into spending without concern for how many jobs are created, they cannot generate the political will to fix this national economy.
By the way, an interest burden of 15% is above the uncomfortably high level of the household debt service ratio. 25% (with exceptions) is the level of debt of a household about to become homeless. There is a limit to the level of debt that countries can carry, and it can be deduced by principles similar to those surrounding household debt: figure out a reasonable level for the big expenditures, things like Medicare and Social Security. Subtract out a minimal amount for national defense (Say, 2% of GDP, which is the European level of spending). How much is left over to accomplish anything else?
The upper limit that debt can ever achieve, then, is that sum, divided by the expected interest cost. One can debate the exact size of that number. It is not, however, infinite, nor even that much larger than what the debt is today.
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