Update on Current Situation – October Jobs Report and 3rd Qtr GDP

Posted by Jim Luke — November 5, 2011

Two of the more important (U.S.) economic measures were reported in last week and half. Yesterday the October jobs report came in. The week before we got the flash report on 3rd quarter GDP. Both measures were better than feared, not quite as good as consensus expectations of many forecasters, and overall still a disappointment. First let’s look at the numbers and then I’ll comment. CalculatedRisk, as usual, reports the facts on the jobs report:

From the BLS:

Nonfarm payroll employment continued to trend up in October (+80,000), and the unemployment rate was little changed at 9.0 percent, the U.S. Bureau of Labor Statistics reported today.
…

The following graph shows the employment population ratio, the participation rate, and the unemployment rate.

Click on graph for larger image.

The unemployment rate declined to 9.0% (red line).

The Labor Force Participation Rate was unchanged 64.2% in October (blue line). This is the percentage of the working age population in the labor force. The participation rate is well below the 66% to 67% rate that was normal over the last 20 years, although some of the decline is due to the aging population.

The Employment-Population ratio increased to 58.4% in October (black line).

Note: the household survey showed another strong gain in jobs, and that is why the unemployment rate could decline with few payroll jobs added – and the employment population ratio increase.

The second graph shows the job losses from the start of the employment recession, in percentage terms. The dotted line is ex-Census hiring.

Now we reach back to October 27 and CalculatedRisk again:

From the BEA:

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 2.5 percent in the third quarter of 2011 (that is, from the second quarter to the third quarter) according to the “advance” estimate released by the Bureau of Economic Analysis.

The acceleration in real GDP in the third quarter primarily reflected accelerations in PCE and in nonresidential fixed investment and a smaller decrease in state and local government spending that were partly offset by a larger decrease in private inventory investment.

The following graph shows the quarterly GDP growth (at an annual rate) for the last 30 years. The dashed line is the current growth rate. Growth in Q2 at 2.5% annualized was below trend growth (around 3%) – and very weak for a recovery, especially with all the slack in the system.

So what’s happening. Nothing much, really. That’s the problem. The economy is effectively going sideways. Yes, we continue to grow, but the rate of growth is so slow that we aren’t really seeing any improvement in conditions. For all of 2011 we have grown at a rate below the long-term historic trend of 3.0%. We are struggling to keep up with population growth and not really doing anything to “put people back to work”. hat’s not a recovery. That’s society throwing 5% of our workforce off the bus 3 years ago and saying “so long” forever. It should be unacceptable, especially when it’s possible to do much better.

John Stossel Fails an Education Test and Demonstrates That He’s Economically Illiterate

Posted by Jim Luke — September 22, 2011

John Stossel is a Fox Business News reporter. Stossel is an unabashed “libertarian” with a strong Austrian orientation on economics who focuses on economic issues. He’s made a living out of being indignant and disgusted by “liberals” and “big government” which he sees as the root of all economic problems. He’s been quite successful over the years, first at ABC News and now at Fox. He also writes a blog to go with his Fox News show.

In other research I was doing recently I stumbled upon a post of his from Sept 15 called “Stupid in America” in which he asserts that schools have gotten too expensive and don’t deliver the goods. In Stossel’s own words and graph:

School spending has gone through the roof and test scores are flat.

While most every other service in life has gotten faster, better, and cheaper, one of the most important things we buy — education — has remained completely stagnant, unchanged since we started measuring it in 1970.

It looks appalling right? Scores have increased by 1% but the cost of an education appears to have increased by approximately 246% ($43,000 up to $149,000). Except it’s very deceptive and the obvious product of an economic illiterate. There’s two clear, elementary economic errors here.

First, he’s comparing test scores, a measure that’s in absolute terms on fixed scale to dollars spent in nominal terms over a 40 year period. Dollars are not fixed units of measure. They change value over time because of inflation. If you want to compare test scores to dollars spent “buying” those test scores, then you need to use real dollars with the inflation taken out.

So let’s do that. Using the Bureau of Labor Statistics CPI Inflation Calculator, we find that what $43,000 purchased in 1970 would require $241,660. in 2010. Yes, inflation has changed purchasing power that much. Inflation compounds so even a 2% annual inflation rate would more than double nominal costs in 40 years. In the late 1970′s we had some years of inflation in the double-digits. So really, the graph is telling us the opposite of what Stossel wants us to believe.

The second big problem is that Stossel is assuming that the all money spent on education goes to buying improved test scores in math, science, and reading. He also is assuming that the inputs, the students being educated are the same in 1970 as in 2010. They aren’t. He ignores that we might be paying for something else in addition to math, reading, and science test scores.

Stossel then goes on the attribute all of the problems to education being a government monopoly. Again, he ignores facts. Facts are inconvenient for Stossel. Competition has been brought to K-12 education in many areas. Maybe not as much as he would like, but it’s a significant change since 1970. As his test scores indicate, it hasn’t helped much.

Finally, I want to note that it’s poor practice to not cite your sources and more precisely define your data series. The graph is labeled “Source: NCES”. NCES is a huge website and archive of a lot of data. Stossel doesn’t give a source. Is it because he wants us to take him at his word and not verify or check it out for ourselves? He doesn’t even label what the spending series is to which he refers. I am assuming it is a “spending per pupil over 12 years” type of series. A search of NCES for a series labeled as he has it turned up nothing.

I find it enormously ironic that Stossel would make such elementary errors as to not deflate a data series or to not label his measures precisely. That’s what we demand in principles of economics courses. What makes it ironic is that on August 23 Stossel takes Congress to task for being “economic illiterates” and not having degrees in economics or business. Pretty rich stuff from a guy with only a psychology degree who makes elementary economic errors.

UPDATE on President Obama’s Jobs Proposal – Better, But Still Weak

Posted by Jim Luke — September 16, 2011

First an update on a post I made a few days ago. When I commented last Monday on President Obama’s jobs proposal, I was less than excited. Having read more detail of the proposal, I should correct some statements I made. I incorrectly left the impression that the payroll tax (Social Security/Medicare tax) cut that the President was proposing was only an extension of the present year cut that is scheduled to expire December 31, 2011.

In fact, the President is proposing not only a 1 year extension of this year’s temporary payroll tax cut, but an increase in the size of that tax cut. Estimates are that for a median household income of near $50,000, it would result in a $1,500 reduction in payroll taxes compared to not having any payroll tax cut at all. However, the existing, this-year only, payroll tax cut had already cut payroll taxes by up to $500 per household. So of the claimed $1,500 tax cut for next year for the median household, $500 is an extension of this year’s situation and $1000 is new stimulus. Today’s economy is weak even with the existing temporary $500 tax cut, so extending that cut won’t improve things. It will only prevent things from deteriorating further. In my world, simply agreeing to not put on the brakes is not the same thing as actually hitting the accelerator.

But, the proposal does contain perhaps $1000 worth of tax cut stimulus to nearly all working households. That’s perhaps $150 billion of pure, new stimulus to economy. It’s more than I estimated on Monday, so the plan will likely have some more stimulative effects than I thought. But how much? Let’s do a quick “back of the envelope” type calculation. The proposal puts $150 billion in consumers’ hands that wouldn’t have been there without it. But for this money to generate jobs, people have to spend the money. Simply saving the money or paying down debt won’t cut it. That improves individual household balance sheets but it doesn’t cause any firm out there to go “oh, more business! I need to hire people!” In normal times like the 1960′s or 1970′s people would have spent 85-90% of the tax cut. But these aren’t normal times. We live in high debt, high debt payments, and scared-of-the-future times. More people save in these kind of times. (paying down debt is economically the same as savings – think of your debt as a negative balance in a savings account). Let’s assume that people spend 2/3 of the money. Both history and theory indicate that people save more of a tax cut when they know it’s temporary, but let’s be generous/optimistic and say 2/3 gets spent. That’s $100 billion in new spending.

Now when it gets spent, it generates business demand and jobs. Those people get paid and then they go spend the money again – the circular flow of money in the economy. How much? That’s a huge controversy in empirical macroeconomics. This is the question of what the spending multiplier is. Estimates vary widely, although often the studies are heavily biased by ideology to begin with. Let’s be modestly optimistic and say the multiplier is 1.5 – 2.0. This is a relatively high estimate given recent studies as far as I know, but let’s run with it. That means that after some months, this initial $150 billion in tax cuts becomes $100 billion in new, initial spending which ultimately increases total spending by $150-$200 billion. Total spending is another way of saying GDP. This puts it in the range of 1.0% to 1.5% of GDP.

There’s a rule of thumb about the relationship between changes in GDP to changes in unemployment rate. It’s called Okun’s Law. It’s not a law so much as a statistical regularity. There are many versions, but let’s use a real simple one: each 2 percentage point change in GDP equates to a 1 percentage point change in the unemployment rate. So if we have GDP growth increasing by 1.5% points, we can count on unemployment rate going down by 0.75 to 1.0% points.

We’re currently over 9% unemployment rate and stuck there. I’m not real excited about a proposal that aims to reduce the unemployment rate from over 9% to maybe 8%. We know 4-5% unemployment is possible. We did it in 2006 even with the slow-growth policies of the Bush administration. We did better than that under Clinton. In the 1960′s we were even below 4%. Why are we settling for tepid responses and setting goals of only getting to 8% unemployment and then calling this “bold”? I don’t know. But then maybe I’m just a grumpy old man.

State and Local Job Cuts are Accelerating, Making the Economy Worse and Cutting Education

Posted by Jim Luke — September 7, 2011

Nicholas Johnson at the Center on Budget and Policy Studies explains how state and local governments are cutting jobs and how a majority of those jobs lost are education jobs.

September 2, 2011 at 1:24 pm

Today’s jobs report shows that in August, cuts by states and local governments — especially school districts — wiped out private-sector job gains.

The state and local sector cut 15,000 jobs in August. That comes on top of a whopping 66,000 jobs lost in July, according to revised figures released today — the worst single month of job loss for states and localities since the recession began in December 2007. States and localities have eliminated 671,000 jobs since employment peaked in August 2008 (see first graph).

Not coincidentally, July was also the first month of the new fiscal year for most states, one in which they are facing the double-whammy of weak revenues (which remain well below pre-recession levels) and the expiration of temporary federal aid.

Some 14,000 of the state and local jobs lost in August were in local school districts, bringing to 293,000 the total decline in school-district employment since August 2008 (see second graph).

Cuts in state education funding are a big reason behind these education-related job losses. As we reported yesterday, the vast majority of states for which data are available are cutting basic education grants to local school districts to below pre-recession levels. Some of the cuts exceed 20 percent.

These troubling numbers raise a disconcerting question: What kind of an economic future will this country have if we keep cutting education?

The Federal Government HAS Been Cutting Spending – And That’s A Major Problem

Posted by Jim Luke — September 7, 2011

One of the my major frustrations as a blogger and as a follower of economic news is the way in which misinformation and falsehoods get repeatedly passed around as they were facts. For example, one common meme that we hear a lot is that the government, especially under Obama, has engaged in a massive spending spree. The idea is pushed that government is growing out of control. This idea has been pushed heavily by Republicans and Tea Partiers. It is often combined with the conclusion that “stimulus doesn’t work”. The unfortunate part is that this idea of a government spending spree is completely untrue!

Look at this graph from the FRED database at the stlouisfed.org. This shows the annual change in real dollars in government consumption and investment expenditures. In other words, it shows how additional spending was added each year by all layers of government in the U.S. During the recession, 2008 and 2009, governments were spending more. They were spending approximately $60 billion a year more. But notice that once the “official recession” ended in 2009 (the end of the shaded bars) governments began cutting back. By late 2010 government has cut back so much that it is now spending less each year than the last year.

It’s no coincidence that this is the same exact timing when two things happened: the Republicans asserted control over the House of Representatives and began pushing to cutting spending, and the economy began to slow again and the recovery stalled. These two phenomena are related. Cutting government spending when there is high unemployment and a slow economy is a sure-fire recipe for an even slower economy and even higher unemployment.

A critical thinking reader might ask “how can this be true (that government spending is lower than a year ago) if the federal government deficit is so large?”. Well there’s two explanations. The first is that the federal government deficit in the economy is largely due to the slow down in tax collections and the tax cuts that delivered little economic stimulus since they were saved, not spent. Second, government in the U.S. is more than Washington D.C. There’s as much state and local government as there is national government, particularly when it comes to spending (as opposed to transfer payments). State and local governments are cutting back and cutting back big time. The 2009 “stimulus” bill of the national government actually had a large component that involved the national government transferring money to states and locals so they wouldn’t have to cut as much. State and local governments cannot run deficits the way the national government can (they don’t have central banks). That’s over now. Now state and local governments are cutting big time – over 345,000 jobs lost at the state and local government level in just the last 12 months. Of those, the majority are teachers in education.

GDP and GDI: Two Sides of the Same Coin (Theoretically)

Posted by Jim Luke — September 6, 2011

One of the starting points for understanding macroeconomics is to understand basic measures of the economy and what we call the “circular flow” of goods and services. The “circular flow” refers to the idea that firms are the economic “agents” who produce and sell all our goods and services for sale, and that households are the folks who consume those goods. Of course in reality, both groups are made up of the same people, but we divide up the activities into firms and household consumption. Given this division of activities into two groups, the circular flow is the idea that the groups both buy and sell to each other. Households buy the products sold by firms, but households also sell their labor to the firms. This is all good and it shows how interdependent firms and households are. Firms can’t hire and pay if they don’t sell products, but households can’t buy those products unless they are able to sell their labor to the firms.

We generally measure the size of an economy by adding up the total value of all the goods and services that are produced and then sold. This is what we call GDP – Gross Domestic Product. GDP is the accepted way to measure the size of an economy. The GDP number as observed and estimated each period is what should technically be called Nominal GDP. It’s the starting point for estimating Real GDP. Real GDP is GDP adjusted for changes in the overall level of prices – it takes the inflation/deflation out of the GDP numbers so we can compare GDP from different time periods.

The GDP numbers as reported by the government agencies is generally computed by observing and at times estimating how much spending happened. In other words, it’s an attempt to add up the value of all final sales by firms of the products they produced. A “final” sale means the product has been sold to someone who intends to use it up or consume it as opposed to reselling it or making it into an even better product.

There is however another way to estimate GDP. Since the total value of what firms produce is the money the firms receive, then we could look at how that money is disposed of by those firms. Put in other words, instead of looking at what households spend to buy goods and services, we can look at the income households received. We could look at the other side of the circular flow. When calculated this way, we give it a slightly different name: Gross Domestic Income or GDI. Because of the circular flow, the two sides shoudl be the same. In other words, in theory GDP should equal GDI. In general and over the long haul they do.

Of course theory and practice sometimes differ. On a quarter-by-quarter basis, GDI and GDP differ slightly because of difficulties in measuring precisely – what we call statistical discrepancy. Occasionally the discrepancy is bigger than other times for reasons economists don’t fully understand. The first half of 2011 was one of those periods. So was 2007. But as you can see from this graph (thanks to James Hamilton at Econbrowser), in general GDP does equal GDI.

Jobs And Unemployment Report For August 2011 – More Bad News, More Signs Economy Is Stalled, No Net New Jobs

Posted by Jim Luke — September 2, 2011

This being the first Friday of the month, the latest U.S. employment report was released this morning. Not good news. In a nutshell: no new net jobs created and the unemployment rate holds steady at 9.1%. It disappointed even the weak expectations of forecasters. The news continues to show an economy that has stalled without recovering and is in danger of relapsing to recession. CalculatedRiskBlog does it’s usual exemplary reporting of the latest monthly jobs and unemployment report:

From the BLS:

Nonfarm payroll employment was unchanged (0) in August, and the unemployment rate held at 9.1 percent, the U.S. Bureau of Labor Statistics reported today. Employment in most major industries changed little over the month. Health care continued to add jobs, and a decline in information employment reflected a strike. Government employment continued to trend down, despite the return of workers from a partial government shutdown in Minnesota.
…
The change in total nonfarm payroll employment for June was revised from
+46,000 to +20,000, and the change for July was revised from +117,000 to +85,000.

The following graph shows the employment population ratio, the participation rate, and the unemployment rate.

Click on graph for larger image in graph gallery.

The unemployment rate was unchanged at 9.1% (red line).

When looking at the detailed numbers we find that the private sector created a net total of 17,000 new jobs. Unfortunately this was entirely offset by government reducing employment by 17,000 jobs. I suppose for Tea Party and Conservative types who blame government for most all economic ills and who fantasize about a society with no government, this is moving towards their ideal economy. Somehow, I don’t see it that way.

Further details behind the numbers show that the number of private sector jobs was likely understated by 45,000 since during the survey week the 45,000 Verizon workers who were on strike were not counted as having jobs. Those jobs will return in the report on September, assuming Verizon doesn’t lay off some of them.

Overall, the picture for recovering from the Great Recession has been turning bleaker. We were never on a very robust path for recovery at all during the last 2 years. However, now what modest slow momentum we had towards job recovery has stalled and job recovery has essentially flatlined. At the current rate, we never recover the jobs lost in 2008-09 until at least a decade has passed, if that. This is definitely starting to look like depression territory, not “recession”. The following graph, also from Calculated Risk,

The second graph shows the job losses from the start of the employment recession, in percentage terms. The dotted line is ex-Census hiring.

The red line is moving sideways – and I’ll need to expand the graph soon.

The current employment recession is by far the worst recession since WWII in percentage terms, and 2nd worst in terms of the unemploymentrate (only the early ’80s recession with a peak of 10.8 percent was worse).

The details in the report also show more depressing (sorry for the pun) news:

U-6, an alternate unemployment rate measure that includes both traditional unemployed (no job but looking), part-time workers who want but can’t full-time hours, and some other marginally-attached workers has risen to 16.2%, a new high for this year.
There are 13.967 million Americans unemployed now.
Of those unemployed workers, 6.0 million have been without a job and looking for work for over 6 months.
The previous reported totals for both June and July were revised downward.

The Mess We’re In – Trillions of Dollars of Missing GDP

Posted by Jim Luke — August 29, 2011

According to the Congressional Budget Office (CBO) the U.S. has a cumulative output gap of $2.8 trillion so far since the recession began. That’s trillion with a TR, as in a million millions. This is the core problem in the U.S. today and for the next couple years. The recession saw the economy shrink and we simply ~~haven’t~~ aren’t getting back to where we were, let alone to where we could be.

Two of the most basic concepts in economics are the idea of opportunity costs and the technique of the counter-factual. Both play a part in this analysis. First, opportunity cost is the idea of the real cost of something or some choice isn’t the money expended but rather what you could have done but didn’t/can’t because of your choice. Analyzing opportunity costs involves using the other idea, the technique of the counterfactual. A counterfactual is a hypothetical outcome that could have been or even would have been, but didn’t happen because of the choices made. People use counterfactuals often, they just don’t call them such. For example, if you imagine decide not to go to a party and you choose to stay home one night, you might imagine what would have happened if you had indeed gone to the party. That’s a counterfactual. It could be good and attractive (you would have had fun at the party and met someone very interesting) or it good be negative (you would have gotten drunk, tried to drive home, and got arrested for DUI). Comparing actual events to counterfactuals is integral to economic analysis.

In the case of macroeconomics, we often use a counterfactual called “potential GDP”. Potential real GDP is the amount of real GDP that would have been produced IF we had made policy choices that produced full-employment. In practice potential real GDP is often estimated by a combination of extending the long-run trend line of GDP from previous decades and of calculating output per worker and multiplying times the number of potential workers. In this case, the additional workers include not only those presently recorded as “unemployed” but also those workers or part of the population that used to work but are no longer working or classified as unemployed. It’s a fairly involved statistical undertaking, but fortunately we have the CBO to do the heavy lifting for us. The numbers and graphs are accessible via the wonderful FRED database at the St.Louis Federal Reserve bank. The data series is called GDPPOT.

The CBO released it’s latest long-run estimates for GDP. Here’s a graph comparing potential real GDP to actual Real GDP. It shows actual numbers for 2008- first half of 2011. From then on it’s the CBO’s best estimates of future actual real GDP given present government policies.

Yeah, that’s an ugly gap between those two lines. That’s the opportunity cost of lost potential. We could have been $2.8 trillion dollars better off over the last 3 years (cumulative, not annual). We could have had tens of millions more working. But we didn’t. More disturbing is that we will continue to underperform for many years. The CBO doesn’t project getting back to full-employment and our achieving our potential output until the end of 2015 – four years from now.

But now here’s the catch. The CBO estimates and analysis don’t offer any rationale or reason why they suddenly forecast a recovery in 2015. Basically they are saying that surely something will happen in 2015 to bring recovery, but they can’t point to any policies or dynamics that will cause such a recovery.

My own sense is that this will take a lot longer to recover given the government’s current focus on debt, deficits, and cutting spending. It’s the wrong policy mix to achieve full employment given this kind of output gap. We will eventually get back to full employment – if nothing else, sooner or later people die off and equipment rusts away. But we’re in the middle of an ongoing depression and current policies won’t change that. (note I said depression, not a “Great depression”)

GDP for 2nd Quarter Revised Downward

Posted by Jim Luke — August 26, 2011

As is normal practice, the BEA released the second estimate of 2nd quarter GDP growth. GDP growth was definitely even slower in 2nd quarter than previously reported. CalculatedRiskBlog tells us:

From the BEA: Gross Domestic Product, Second Quarter 2011 (second estimate

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 1.0 percent in the second quarter of 2011, (that is, from the first quarter to the second quarter), according to the “second” estimate released by the Bureau of Economic Analysis.

This was revised down from 1.3% and slightly below the consensus of 1.1%.

Exports subtracted more from GDP - as did changes in private inventories. Consumption of services and fixed investment were revised up slightly.

The following graph shows the quarterly GDP growth (at an annual rate) for the last 30 years. The current quarter is in blue.

Click on graph for larger image in graph gallery.

The dashed line is the current growth rate. Growth in Q2 at 1.0% annualized was below trend growth (around 3%) – and very weak for a recovery, especially with all the slack in the system.

Calculated Risk goes on to report on the breakdown of what sectors accounted for what part of the growth (or absence of growth). The two most significant negatives were Personal Consumption of Goods and State/Local Government Spending. Both contracted sharply and each had the effect of lowering the GDP growth rate by 0.34 points. A 1.0% annualized growth rate is really not good at all. It’s horrible in fact. And that means it’s not the time to be cutting state and local government spending. The federal government really could do something but there’s no political will in Washington.

Is Debt-to-GDP a Good Measure?

Posted by Jim Luke — August 4, 2011

In a previous post, reader Sergei asks

Hello, I appreciate your article, however, I still wondering what is the meaning of the National Debt over GDP ratio? My numbers based on the US debt clock http://www.usdebtclock.org/index.htmlshow me that this ratio currently around 98%. Could you briefly explain what is the meaning behind this number?

Others might find the answer useful, so I’m making a post out of my response.

The “national debt” is the total money borrowed by the national government. It is the sum total of all the bonds and T-bills that have been issued and still outstanding by the U.S. government regardless of who owns (the lender or creditor) the bonds. In some cases, one unit of the government such as Social Security owns the bonds which means in effect that one part of the government owes money to another part of the government. In other cases, the central bank, The Federal Reserve, owns the bonds. For details on the breakdown on the U.S. debt see here.

For centuries, nations have borrowed money and for centuries, there have been national governments that have found themselves unable to pay back the money or at times to even pay the interest on the money they borrowed. These events are called “sovereign defaults”. Economists are interested then in the is How much debt is too much? Can the government bear the interest costs of the debt? It is much the same kind of question that a bank asks about an individual when making a loan to an individual. But there are important differences.

In doing this we are trying to compare the amount of debt to some measure of the government’s ability to make the payments. The debt-to-GDP measure is simply a percentage number using total debt outstanding as the numerator and the size of GDP as the denominator. We use GDP as a measure of the government’s ability to pay since a government’s income is taxes. The taxes that can be collected depend on the total of all economic activity. After all, you can’t collect taxes of $1 trillion from an economy of only $500 billion, but it’s easily plausible to collect $1 trillion in taxes from an economy of $15 trillion. The higher GDP is, the more it is assumed the government has an ability to collect taxes and pay the interest. Thus when the ratio is higher, it indicates that a lot of debt is outstanding and that implies (but only implies, not requires) a lot in interest payments. So, it is assumed by many that a higher debt-to-GDP ratio means interest payments are likely a greater burden and thus the chance of eventual default higher.

Using a debt-to-GDP ratio carries two major advantages over just using amounts of debt. First, it allows us to compare two different countries regardless of their size. For example, we can compare a small, little country like Greece which has a debt-to-GDP ratio that’s around 153% to a very large economy like say Germany which is around 84%. Even though Greece has much, much less actual debt outstanding, it’s debt is a bigger burden on it than Germany’s debt is for Germany because Germany has a bigger economy and more ability to pay. Second, using the ratio allows us to compare debt levels of a country from different years. Debt may be growing in dollar terms but becoming less of a burden because the country’s GDP is growing faster. This was the experience of the U.S. since World War II. In WWII debt-to-GDP reached 112%. Ever since then, the U.S. has had an increasing debt because it almost always ran a budget deficit. But the debt-to-GDP ratio declined from 1948-1981 because the economy grew so fast.

Why There’s So Much Attention to the Ratio In Recent Years

I’ll let noted economist Robert Shiller explain in his article in Japan Times (btw, this is an excellent, easy to read article – I recommend reading it):

A paper written last year by Carmen Reinhart and Kenneth Rogoff, called “Growth in a Time of Debt,” has been widely quoted for its analysis of 44 countries over 200 years, which found that when government debt exceeds 90 percent of GDP, countries suffer slower growth, losing about one percentage point on the annual rate.

One might be misled into thinking that, because 90 percent sounds awfully close to 100 percent, awful things start happening to countries that get into such a mess. But if one reads their paper carefully, it is clear that Reinhart and Rogoff picked the 90 percent figure almost arbitrarily. They chose, without explanation, to divide debt-to-GDP ratios into the following categories: under 30 percent, 30 to 60 percent, 60 to 90 percent, and over 90 percent.

And it turns out that growth rates decline in all of these categories as the debt-to-GDP ratio increases, only somewhat more in the last category.

There is also the issue of reverse causality. Debt-to-GDP ratios tend to increase for countries that are in economic trouble. If this is part of the reason that higher debt-to-GDP ratios correspond to lower economic growth, there is less reason to think that countries should avoid a higher ratio, as Keynesian theory implies that fiscal austerity would undermine, rather than boost, economic performance.

The Problems With the Ratio

One major problem with the ratio is that people misunderstand it, as Shiller explains. Many people think that a ratio of over 100% means the country is insolvent or bankrupt. That’s false and a fallacy. Many mainstream economists claim to be uncomfortable with ratios of over 90%, but that’s purely an arbitrary pick that reflects ideology more than economic experience. Japan, for example, has been running a ratio of well over 200% for a decade with no signs of default. In fact, investors think the Japanese government and economy are solid enough that the Japanese government borrows money at the lowest interest rates in the world.

Another very serious problem with the ratio is that when the ratio goes up, people assume it is because of deficit spending and borrowing. In reality, most times when ratios go up it is because a recession or austerity program has shrunken the size of the economy and GDP. For example, since 2007 the U.S ratio has gone up a lot. But most of the increase has been because of the decline in GDP, not because of the stimulus spending program.

Finally, the last problem with measure is the very idea that it measures likelihood of default. The empirical data on the relationship is weak. Most importantly, default really happens when the debt-to-GDP ratio goes up AND the country borrows in somebody else’s currency (like small developing nations) AND the country has either fixed exchange rates or a gold standard. These conditions apply to those nations that are part of the Eurozone – the countries that use the Euro as their currency. These conditions also apply to many smaller developing nations. These conditions absolutely DO NOT APPLY to large developed nations with their own currencies such as the U.S., U.K., Canada, Japan, Australia, Switzerland, and many others.

So, overall, the ratio is actually a pretty poor measure. It’s useful in some esoteric technical econometric studies, but as a guide to whether the nation should cutting spending or not, it’s a horrible measure.

For the reader who is curious, data comparing different countries debt-to-GDP ratios can be had from the CIA Factbook here.

Economicshelp.org offers some graphics comparing these concepts for the U.S. historically:

There are different ways of measuring US National debt.

Firstly, there is the actual value of debt. This shows that (even adjusted for inflation) the value of debt has increased significantly over the years

In 1900, US debt was $43.6bn (2005 prices)

In 1945, US debt was $2347.41 bn (2005 prices)

In 2010, US debt was $12032.28 bn (2005 prices)

Though there were a few periods in the 1920s, 1950s and 1960s when the real value of debt was actually being reduced.

from: wikipedia US Debt

The Public debt is the US debt held by private sector.
Gross debt includes debt that the government holds itself.

EconProph

Category Archives: Measures & Statistics