…because I’m an economist and a mom–that’s why!

Is There Such a Thing As an Unsustainable Level of Debt?

May 28th, 2010 . by economistmom

My short answer is: “no.”  Debt is a stock concept, not a flow one.  To determine whether something is “sustainable” or not (whether it be the government’s fiscal condition, a family’s personal finances, environmental quality, one’s physical health, or even personal relationships) requires a look at the dynamics of the situation, not just a snapshot.

I mention this because there’s been a lot of buzz among fiscal policy economists over the past couple days, ever since the President’s fiscal commission discussed the idea of setting a specific level of gross federal debt to GDP as a policy goal.  Experts from all sides attacked this notion immediately, focusing on the “gross” part.  They emphasize that economically, it’s really net debt, or debt held by the public (investors whether American or foreign), that matters.  Jim Horney of the (left-leaning) Center on Budget and Policy Priorities explains this very well, and Andrew Biggs of the (right-leaning) American Enterprise Institute agrees.

My objection is on the emphasis of a particular level of debt–whether gross or net, actually–as some sort of magical number that would trigger a particular set of bad economic outcomes if we were to reach it.  Here, I think I agree with Paul Krugman’s sentiment when he wraps up his complaint with (my emphasis added):

So what’s happening is that the idea that Really Bad Things happen when [gross] debt crosses 90 percent of GDP is being treated as a solid fact, when it’s nothing of the sort. And if the Obama commission feeds that false perception, right there it’s doing a lot of harm.

But… I agree with Paul’s sentiment not because I think the debt (whether gross or net) is nothing to worry about, but because we should worry about it–not for the particular level it’s at right now and not even for any particular level it may reach by some date in the future, but for the whole dynamic path we see it taking from here forward.  In other words, roll the video; don’t just study the photo.

What makes the fiscal outlook unsustainable is not that there exists a debt (which is good thing to be able to carry by the way) and not even that the debt will be larger in the future (which also can be a good thing if it allows us to grow our income by even more in the future).  What makes it unsustainable is that the moving picture of the debt shows it growing faster than our economy (our capacity to pay the costs of carrying that debt).  And if you look around at the scenery in this video, you realize that there’s nothing yet visible on the stage or in the scene that will do anything to change that scary course we’re on.

I think it’s impossible to label any particular level of gross OR net debt to GDP as the “breaking point” for our economy.  It’s easier to point to a particularly high particular level by a particular time–such as net debt reaching 100% of GDP within the next ten years–as “well, yes, that’s certainly sufficiently unsustainable.”  I have said something like that often, but even then, not because debt (a stock) equaling 100% of GDP (a flow) means anything.  Such a level of debt would be unsustainable for a number of factors, all of which are “moving” pieces that aren’t moving in the right directions.  Our federal spending commitments via the entitlement programs are only increasing.  Our investments in things that would grow the economy over the long term and preserve our resources for the long term seem to be shrinking.  Our revenue base is at best stagnating–certainly not keeping up with our needs.  And our indebtedness is increasingly to foreign investors rather than to other fellow Americans.

These are all the moving pieces that make our fiscal situation unsustainable, and to point to a particular measure of debt as telling the story sells the story short and perpetuates the propaganda that fiscal hawks are just a bunch of “fearmongerers” full of Chicken Little stories that are just a bunch of bull.  The story of fiscal unsustainability is not a bunch of bull.  You just need to watch the video to understand it.

7 Responses to “Is There Such a Thing As an Unsustainable Level of Debt?”

  1. comment number 1 by: Len Burman


    I agree with the general thrust of your post, but not with your simple short answer. It’s a really complicated question.

    Ignoring the role of the Fed, debt is clearly unsustainable if the maximum primary surplus is less than interest on the debt (this is a simplification that ignores dynamics of gdp and interest rates, but is useful for thinking about the problem). That sounds like it’s really far away. Right now, interest is less than 2 percent of GDP, which is easy to manage. But, in fact, we have no idea when the threshold of unsustainability will be reached. Interest rates could spike because markets question the future sustainability of the debt, which would depress the economy, lowering GDP. If the government, facing very high borrowing costs, decided to raise taxes and cut spending, that would further depress the economy. Bottom line: interest as a share of GDP could rise to unsustainable levels very quickly.

    The Fed would, under certain circumstances, be able to mitigate such a debt crisis. It could buy the Treasury debt when the markets balk, but that would massively expand the money supply, which would tend to be inflationary. Only if the federal government had a credible plan to quickly buy back the debt from the Fed could inflationary expectations be dampened, but that would mean that the government would have to run substantial primary surpluses until the debt were reduced enough that financial markets judged it sustainable. If the starting point were one of large primary deficits, the extreme fiscal tightening of such a policy might precipitate a depression, which might make paying down the debt infeasible.

    So sustainability depends on perceptions of markets, the size of the debt, the size of primary surplus or deficit, and the state of the economy (its tolerance for fiscal tightening). I’d guess that we’re not at tremendous risk of a debt crisis right now because the eurozone crisis has made Treasuries seem relatively attractive and our debt is not yet enormous. But given the skittishness of financial markets, the size of our deficits, and the fragility of our economy (and the world’s), there’s cause to worry even in the short run.

    I don’t think that’s a reason for deficit reduction in the short run, because it could depress a really weak economy, but it is reason to develop a credible plan to tame the debt over time.

  2. comment number 2 by: economistmom

    Len: You’re right– my simple short answer to summarize what’s really a very complex point may get misunderstood. What I meant to say was there’s no such thing as a particular level of debt at a particular point in time that puts that debt just over the “unsustainable” line. I guess I should have titled this post “Is There Such a Thing As a Particular Level of Debt at a Particular Point in Time Being the Defining Characteristic That Renders That Debt “Unsustainable”?” That’s what I’m giving a simple “no” to. Certainly if we’re already at a particular level of debt (having nothing to do w/ its path) that is “unsustainable,” then we have nothing–or everything–to worry about, but the main point would be we would not be in a position to be able to change the “unsustainable” outcome. I am much more optimistic than that. The path we take from here forward matters, and it’s the path we should be focused on, NOT just a particular place we’re at now or 10 or even 20 years from now. In other words, fiscal responsibility “is a journey, not a destination.” ;)

  3. comment number 3 by: Jim Glass

    For the record, a little while back CBO projected the “Effect of Rising Budget Deficits on Real GNP per Person” — see Figure 3 for a picture of the decline and fall of GNP as deficits rise.

  4. comment number 4 by: B Davis

    Experts from all sides attacked this notion immediately, focusing on the “gross” part. They emphasize that economically, it’s really net debt, or debt held by the public (investors whether American or foreign), that matters.

    There are experts that disagree. For example, following is an excerpt from page 56 of the IMF’s recently-released Fiscal Monitor:

    Rollover risk: gross debt tends to be the natural choice to assess this type of risk, as it
    is the gross debt stock that countries need to roll over. Assets can matter as well if
    they are sufficiently liquid, as they can be sold and the proceeds used to retire
    maturing debt. Given that reliable cross-country data on asset composition is scarce,
    however, basing the analysis on gross debt is often preferable.

    Impact on interest rates and growth: whether net debt or gross debt is more relevant
    for assessing the impact of debt on interest rates and economic growth is mostly an
    empirical question, as good theoretical arguments could be made to support the
    choice of either indicator. The analysis in this issue of the Monitor uses gross debt to
    investigate these impacts, in part because data scarcity makes a similar analysis for
    net debt difficult.

    I think it’s impossible to label any particular level of gross OR net debt to GDP as the “breaking point” for our economy.

    Agreed. I was recently looking at this issue and posted what I found at this link. If one wishes to stabilize the debt to GDP ratio at a particular level, there is a relationship that must hold between the average interest rate paid on the debt, the GDP growth rate, the debt, and the primary balance (equal to revenues minus outlay, excluding interest costs). Using i, r, D, and P to represent those four items, the necessary relationship can be represented as follows:

    P = (i - r) * D

    This formula implies something interesting. If the average interest rate (i) equals the GDP growth rate (r) and the government runs a primary balance (P) of zero, then ANY level of debt to GDP can be sustained. In effect, this would mean that we could simply borrow the money needed to make the interest payments on the existing debt. The debt would then grow at the interest rate. If the GDP grew at the same rate (r = i), then the ratio of debt to GDP would remain the same.

    Some might interpret this to mean that the debt is a free lunch and that we can accumulate any level of debt with no ill effects. This would be a serious mistake. For one thing, the formula shows that it is affected by the ongoing primary balance, interest rate, and GDP growth rate. As described at the above link, the outlook for the primary balance is unfavorable at present and in the coming years. Also, a larger debt does represent a larger exposure to increases in interest rates. There may be no precise level at which things break down but the risks do increase. Likewise, there may be nothing special about a debt of 100 percent of GDP. But if enough potential bondholders believe that there is, this could cause a difficulty in rolling over debt and/or a rise in interest rates.

    I agree with Len Burman’s response that it’s a really complicated question. The above simple formula seems to raise as many questions as it answers and is likely incomplete. On page 56 of IMF’s Fiscal Monitor, they seem to expand on it. The fact that there may not be a precise level of debt at which things break down is not to say that the risks of seriously negative effects do not increase. I think that we need to move beyond simplistic notions (like “deficits don’t matter) and side issues (like net debt versus gross debt) and work to identify and mitigate those risks.

  5. comment number 5 by: VAT Brat


    Your question, “Is there an unsustainable level of debt?” approaches the issue incorrectly. Lenders use something called “The 5 “Cs” of Credit.” Lenders look at Character, Capacity, Capital, Capacity, and Conditions.

    When Argentinia defaulted on its debt, it was not due to an inability to pay its creditors. What occured was a change in its political morality. It was a lack of “Character,” the first “C” of credit.

    Their elected officials told its citizens that the lenders corrupted the nation and deserved to be screwed. It was that simple.

    The US faces the same challenge to its political morality. Our body politic is comprised of voters who would sooner pick the pockets of strangers than go to their family, friends, and community for assistance. After all, why ask favors from people who know you best, and know you are likely underserving.

    Bypassing direct face to face confrontation with another citizen possessing greater means these parasites find thuggery and burgulary through the political process to be more respectable and rewarding.

    Who are these parasites? Let’s start with the retirees claim that what they receive in Medicare and Social Security is a return of taxes they invested during their lives. The farmers receiving crop subsidies because they’re convinced we’d starve if we refused them. The public school teachers who earn $60,000 for 9 months of work plus fully paid medical care and a full pension while claiming that children aren’t learning because taxpayers don’t spend enough paying teachers. The corporate interest groups getting tax breaks. The able-bodied high-school-dropout adults receiving Section 8 housing subsidies because they got knocked up when they were teenagers and make us feel miserly if we don’t fork up for childcare services and other subsidies to enable their odious lifestyle choices. The 5′7″ 300 lbs. diabetic smoker who demands free medical care.

    We’re filled with a nation of tax-takers with a sense of entitlement, looking for indulgence of the envy they feel toward others. There are plenty of politicians ready to indulge this envy and very few willing to shame the parasites who petition them for favors. We are woefully short of people who would feel shame about taking tax dollars from their fellow citizens.

    A majority of voters feel their is more nobility in a career organizing other citizens to win government grants than it is to volunteer for service in defense of our nation.

    This is a very small space to travel before these elements in the electorate and their champions in the Legislature conclude that default is the noble course of action. When the time comes that they are called upon to take less and pay more so that commitments made to lenders can be honored, they will be highly receptive to the notion that the lenders owed it to them, anyway.

    Looking at ratios and equations mistakes the symptoms for the cause. Lenders will look at the character of the body politic for the signal when a crisis will start.

  6. comment number 6 by: VAT Brat

    5 C’s of Credit: Character, Capacity, Capital, Collateral, Conditions. I wrote “Capacity” twice and omitted “Collateral” by mistake.

  7. comment number 7 by: Matt Franko

    Youre starting to see it… Stay with the Stocks and Flows. Krugman has met with Warren Mosler and is there but cant quite admit it fully yet for political reasons.

    VAT: I have many of the same concerns about the efficacy/efficiency of Govt spending, but they dont have anything to do with sustainabilty of fiscal policy or “deficits”…. we can continue to overpay these people with higher deficits at the federal level endlessly…but I agree with you it would be a terrible policy. We need reforms of all types in this country but not because “we cant afford it” at this point.