Economists Don’t See U.S. Debt as a Crisis

U.S. growth is picking up despite the federal deficit.

Representative Paul Ryan, chairman of the House Budget Committee, declared this month that the U.S. national debt “is hurting our economy today.” It’s an idea embraced by almost every Republican and even some Democrats.

Economic data -- on jobs, housing and investment -- don’t support that claim. And economists across the political spectrum dispute the best-known study of the subject, by Carmen Reinhart and Kenneth Rogoff, which found that nations with debt loads greater than 90 percent of their economies grow more slowly.

Three years after a government spending surge in response to the recession drove the U.S. past that red line -- the nation’s $16.7 trillion total debt is now 106 percent of the $15.8 trillion economy -- key indicators reflect gathering strength. Businesses have increased spending by 27 percent since the end of 2009. The annual rate of new home construction jumped about 60 percent. Employers have created almost 6 million jobs.

And with borrowing costs near record lows, the cost of paying off the debt is lower now than in the year Ronald Reagan left the White House, as a percentage of the economy.

“The argument that heavy debt loads slow economic growth doesn’t hold a lot of water,” says Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia who oversees $12 billion. “It suffers from a mix-up of cause and effect: When weak economic conditions arise, it tends to encourage deficit spending, which is what has led to more U.S. debt being issued, and not the other way around.”

Republicans like Ryan of Wisconsin, joined by Democrats such as former Senate Budget Committee Chairman Kent Conrad of North Dakota, embrace as economic gospel the idea of a tipping point for debt, even as it is hotly debated among economists.

Some studies have found no evidence that high debt inevitably chills growth -- especially for countries like the U.S. that print their own currency. One 2012 paper by two French economists even concluded that growth rates increased as the debt-to-GDP ratio passed 115 percent.

“The Rogoff-Reinhart 90 percent is really quite a fragile number,” says Joseph Gagnon, a former economist in the Fed’s monetary affairs division. “There is no threshold like that for countries that have control of the currency they borrow in.”

Reinhart and Rogoff said in a 2010 paper that once debt rises beyond 90 percent of gross domestic product for advanced economies, median growth rates are 1 percentage point lower. The U.S. passed the 90 percent mark in early 2010, according to the International Monetary Fund.

 

Lower Growth

“Across both advanced countries and emerging markets, high debt/GDP levels (90 percent and above) are associated with notably lower growth outcomes,” Reinhart and Rogoff wrote, drawing on data from 44 countries over a 200-year period.

Rogoff declined to comment for this story, and Reinhart didn’t respond to e-mails or telephone requests.

To be sure, the U.S. economy is expanding only slowly. Growth over the past three years has averaged 2.2 percent compared with an average of 2.5 percent between 1989 and 2009. And the recent stirring could fizzle, either because of government spending cuts or what Federal Reserve Chairman Ben S. Bernanke described at a March 20 news conference as the economy’s “tendency for a spring slump.”

And while there’s no way to know whether the economy would be expanding faster if the debt burden were lower, the traditional way that government debt hurts growth is by raising the cost of money as public sector borrowing “crowds out” private borrowers. That isn’t happening.

Even as the U.S. continues borrowing to cover this year’s projected $845 billion deficit, bond markets remain untroubled. Yesterday’s 1.91 percent yield in New York on the 10-year Treasury note was lower than on the day President Barack Obama was sworn in for his first term. It’s lower than on Aug. 5, 2011, when Standard & Poor’s lowered the U.S. credit rating. And it’s well below the 5.3 percent average over the past 25 years.

“Financial markets are begging the government to borrow at negative real interest rates for 10-year maturities,” says Gagnon, now at the Peterson Institute for International Economics. “There’s no way our debt is slowing us today.”

Still, those warning about deficits say debt loads can hinder growth by dimming expectations. The prospect of higher taxes or lower government spending needed to reduce borrowing could cause companies and individuals to retrench.

“That has to be hurting us right now,” says economist Douglas Holtz-Eakin, former director of the Congressional Budget Office and an adviser to 2008 Republican presidential contender John McCain.

 

Testing Limits

Testing the upper limit of debt sustainability would be foolish, he said. Maintaining today’s debt load would leave the U.S. unable to easily respond to a future financial crisis by ramping up spending. Plus, when interest rates rise from current low levels, the government’s annual interest burden -- the CBO projects it will be $224 billion this year -- will mushroom.

“Our debt load could be $500 billion overnight,” he says. “Think how fast spreads move.”

CBO projections don’t support that point of view. They predict interest payments will remain below current levels until 2018 when it says economic output will reach $21 trillion. This year, the U.S. will spend 1.4 percent of GDP servicing its debt, less than half the amount in 1989, the year Reagan left office.

Debt hawks take solace from a 2011 paper by the Bank for International Settlements, the Basel, Switzerland-based group that facilitates cooperation among central banks. It said government debt becomes a drag on growth at 85 percent of GDP.

And two IMF economists, Manmohan Kumar and Jaejoon Woo, found “a significant negative effect on growth” above the 90 percent threshold. For every 10 percentage-point increase in an advanced country’s overall debt-to-GDP ratio, growth fell by 0.15 percentage points per year, they said.

That suggests the U.S. economy this year is losing 0.6 percentage points from its growth rate, based on the increase in the gross debt ratio since 2007. The U.S. will grow this year between 2.3 percent and 2.8 percent, according to the Fed’s latest forecast.

Indicators of future activity, however, have yet to reflect such worries. The index of leading economic indicators reached 94.8 in February, its highest level since before the 2008 financial crisis. Stocks are near record highs, and the dollar is up more than 6 percent since Dec. 31, 2009.

Testifying on Feb. 26 before the Senate Finance Committee, Robert Greenstein, director of the Center for Budget and Policy Priorities, said: “The notion that we are already in a danger zone because gross debt exceeds 90 percent of GDP and that this is already costing jobs is not one most economists would agree with.”

 

2009 Book

Reinhart and Rogoff rocketed to prominence following the global financial crisis. Their 2009 book “This Time It’s Different,” which made The New York Times bestseller list and was translated into 20 languages, drew applause from politicians in both parties.

In 2011, the White House cited their finding that recoveries from financial crises are slower and less robust to explain what it called the “disappointing” economy.

“It’s not a particularly reliable gauge,” economist John Makin of the Republican-leaning American Enterprise Institute, a former consultant to the Treasury Department and Fed, said of the 90 percent threshold. “The evidence is not strong.”

Though Reinhart and Rogoff emphasize the number of countries they studied, some economists question whether those examples apply to the world’s largest economy and holder of the global reserve currency.

 “Comparing the U.S. to Sweden or to Japan even, it really just doesn’t cut it,” Drew Matus of UBS Securities LLC told Bloomberg Radio earlier this year.

Thanks to the Federal Reserve, the U.S. is able to borrow more without yields rising. Since the Lehman Brothers bankruptcy in September 2008, the Fed has more than tripled the size of its balance sheet to $3.2 trillion.

The central bank’s bond purchases have kept the 10-year yield 80 to 120 basis points, or 0.8 to 1.2 percentage points, lower than it otherwise would have been, thus boosting economic growth, according to Bernanke.

Dean Baker, co-director of the Center for Economic and Policy Research, called the idea of debt limiting growth “very silly,” saying the U.S. retains vast assets, including technically recoverable oil and gas reserves estimated by the Institute for Energy Research at $128 trillion.

“If it sold off $5 trillion to lower its debt to GDP ratio by 30 percentage points do we really think we would suddenly grow faster?” Baker wrote in an e-mail.

 

Bloomberg News

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