One of the most frequent arguments during the Obama administration has been about the national debt. The U.S.’s debt-to-GDP ratio has soared in recent years. Should we be concerned about its effect on economic growth?
Republicans have screamed, “Yes!”
Democrats have brushed off those concerns. Their argument has been that the recent increases in debt were the result of the Great Recession and should be kept separate from the true driver of our long-run debt problem: health care costs.
The strongest evidence for the Republican position came from economists Carmen Reinhart and Ken Rogoff. They looked at countries with high debt levels and found that once a country’s debt crossed the 90% debt-to-GDP threshold, its economic growth plunged.
This meant that no matter what the cause of our debt, we risked facing diminished growth prospects once we hit that threshold. Given that our current debt is 72% of gross domestic product, we faced an imminent threat. In response to this worry, Congress has cut the deficit by $2.4 trillion over the past few years.
But last year, graduate students at the University of Massachusetts badly damaged Reinhart and Rogoff’s claim when they discovered that the economists had made an error in their excel spreadsheet. After correcting for it and weighing the data slightly different, the graduate students found that the supposedly perilous threshold disappeared entirely.
Now, a new IMF Working Paper deals yet another blow to the theory.
It seems Reinhart and Rogoff collected data on countries that had significant debt burdens and examined the countries’ economic growth in the following year. This analysis has always had a fatal flaw: high debt burdens could cause slower growth or slower growth could cause higher debt burdens.
Recessions reduce economic growth and often increase a country’s debt as automatic stabilizers kick in (as happened in the United States in recent years). Is slower growth the result of the higher debt or vice versa? Many took Reinhart and Rogoff’s analysis to mean it was always the former.
But IMF researchers Andrea Pescatori, Damiano Sandri, and John Simon try to correct for this by looking at growth not just in the following year, but over the next five, ten, and 15 year periods.
“If high debt (that is, debt above some threshold) operates as a drag on growth over anything but the short-run, however, we would expect to observe weak growth not only in the year after the debt ratio exceeds the threshold, but also during the subsequent years,” the authors write.
Here’s what they found:
Over the ten and 15 year periods, higher debt is associated with just about the same economic growth. There’s no threshold at all.
The authors also looked at the economic growth for counties with increasing and decreasing debt. They found that among countries with similar debt levels, growth is stronger over the next 15 years among those with decreasing debt.
This is an important new finding: The debt level of a country is not important. What matters is the trajectory of that debt.
What does that mean for the United States?
It refutes the claim that we risk slower economic growth once our debt hits 90% of GDP. There isn’t some magic threshold that we’ll suddenly hit and see our growth plummet.
But more importantly, it demonstrates that what matters for our long-run growth is putting our debt on a downward path. The reason that the U.S.’s debt-to-GDP ratio is projected to increase in future decades is not from the stimulus or food stamps. It’s from the cost of entitlements as baby boomers retire and health care costs continue to grow.
We have different options for combatting those costs. Implementing austere policies that ignore our long-term issues is not one of them. That kind of thinking only makes sense if the point is to stop us from hitting a certain debt threshold—one we now know is bunk. Austerity does almost nothing to solve our future debt problems.
And yet, that’s what Congress, led by Republicans, has done over the past few years. We’ve slowed the recovery to stop our debt from reaching higher levels while doing little to put our debt on a real downward trajectory. It’s the opposite of what we should’ve done.