[UPDATE, 6-21-2005: see corrections in red below]
Soon I’ll be a grandfather. Because of that, just one of many things I’ve been contemplating recently is the debt burden my generation and the next will bequeath to our grandchildren.
As a starting point, today’s debt burden is—in my opinion—not terribly high. So I’d be comfortable if we could just keep it from getting any higher. (The National Debt Thermometer illustrates why I’m not too concerned about today’s debt burden.)
However, others disagree with me. Some say there’s absolutely nothing wrong with a higher debt burden—in the range of 80%-100% GDP. Others say the opposite—20%-40% of GDP would be more desirable. The people saying these things aren’t dummies, either; they’ve merely drawn different conclusions after weighing the evidence, and I respect all of them.
To gain a better understanding of it, I decided to run some numbers myself, and also to run my assumptions past some experts. I chose two scenarios: (1) cutting the debt burden in half over the next fifty years; and (2) holding it constant for fifty years.
Hold onto your seat; this might surprise you
The two charts below summarize the results. Just above each chart is a summary of what it’s telling us. (Note: Both charts assume that current annual growth of nominal GDP, 6%, is sustained).
Finally, below the charts, I’ve reprinted the question I asked two well-known economists last week (in separate emails), followed by their responses.
Chart 1 says this: To cut the debt burden in half by the year 2055, it’s okay to run a fiscal deficit every year. CORRECTION, thanks to an astute reader who reminded me about the difference between the unified deficit versus the general fund deficit: We should reduce the general fund deficit by almost half, bringing it to a level of 3%, then gradually taper down to 1.2% GDP in 2055.
Click to enlarge.
Next, Chart 2 says this: To prevent the debt burden from growing (i.e., to hold it constant for the next fifty years), we should run fiscal deficits of 3.6% GDP every year. CORRECTION, same reason as above: (Today’s unified deficit is lower than that, but it's being propped up by a social security surplus; we should reduce the general fund deficit by one-third to 3.6%, then keep it there.)
Click to enlarge.
Is this really true? Here’s what the experts told me when I asked them:
I wanted to check my fundamental premise with a couple of experts before posting the charts, so I asked two of them last week. Here was my question to each of them (separately):
“I have what I think is a simple question. The debt-to-GDP ratio, if inflation is under control, is a reasonable benchmark for the ‘debt burden’ according to most economists. (Inflating our way out of a debt burden is unacceptable, and therefore eliminated as a factor in the question below.) The question: Isn't it true, then, that we can comfortably sustain permanent deficits—as long as GDP grows at least at the same rate as the debt?”
[Sidebar: Ideology is not important to me in this analysis; however, it might be to you. So, if you are a liberal, you should pay attention to the first expert below, and ignore the second one. If you are a conservative, you should do the opposite.]
1. Here was James K. Galbraith’s response (...some consider him a liberal; it's immaterial to me):
“Yes, it is a simple question, and yes, your insight is correct.”
2. Here was N. G. Mankiw’s response (...some consider him a conservative; it's immaterial to me):
“I think the simple answer is yes.”
There you have it. The conclusion is this: In a growing economy, permanent deficits of a measured and managed amount, year in and year out, result in a fiscally responsible debt burden. Our grandchildren will prosper if we can start executing this plan now.
Please help me hold our elected leaders’ feet to the fire on this one; let them know we want them to be fiscally responsible, and—just as important—let them know specifically what we mean by "fiscal responsibility."
