Real and Nominal Debt: An Example

In response to my The Inflation Adjustment of Debt, Clonal replied in part:

You may also want to look at Scott Fullwiler's presentation -
What Should Economists Have Learned from the Crisis?

which for some reason opens with a picture of a naked guy doing math at the blackboard.

Took me a few days to get to it -- that Debt and Inflation series really took a lot of time -- but I finally did. The presentation is done in "Prezi", a service I've not seen before. It was pretty easy to view the presentation, intuitive. Not bad, though there did seen to be a lot of zooming in and zooming out.

I even turned on my speakers so I could hear it as well as see it. But there was no audio to be heard. And since it's a presentation -- a sequence of images, not a body of text -- there was nothing to read and follow. So I'm not really sure what the point of the thing was.

I don't really think it had much to do with the inflation adjustment of debt. But I did find one graph in it, that brought me back to that topic:

Source: Rob Parenteau via Scott Fullwiler

See that flat spot there, from 1965 to 1985? It corresponds pretty well with the "Great Inflation" of 1965-1984. Corresponds very well, actually. Thanks, Clonal.

I think the ratio of debt-to-income shown on that graph was influenced by the inflation of those years.

I think I can use my inflation-adjustment calculations, developed in the Debt and Inflation series, to see the extent of that influence.

First, duplicate the graph using FRED data for household debt as a percent of disposable income:

Graph #2: Household Debt relative to Disposable Income

CMDEBT is Household Credit Market Debt Outstanding, and DPI is Disposable Personal Income. Graph #2 continues into 2012; Graph #1 stops about six years earlier, and lacks the tip of the peak and decline. Other than that, the two graphs show similar patterns: increase before the Great Inflation, flat during, and increase again after that inflationary era.

I thought I would use the "ART1" inflation adjustment from mine of May 9th for this post. But I got far enough with that to have second thoughts. I think the "ART1" has a flying base, not a single-year base. I don't think it is compatible with the Surreal inflation adjustment. So I'll use "ART2" instead, taking the most recent year as the base.

Graph #3

To make this adjustment I need the debt numbers and a price series. I wasn't sure what price series to use, so I checked with FRED. Graph #3 compares their "Real Disposable Personal Income" (blue) to "Disposable Personal Income" divided by the deflator (red) and by the Consumer Price Index (green) adjusted to the 2005 base year that the other lines use. The deflator gives a better match. I'll use that.

I went to FRED and gathered up a bunch of data, uploaded it to Google Docs, and combined it into a new workbook. The first time through, I gathered quarterly data, FRED's default. But when I plugged my adjustment formula into the spreadsheet, I ended up with one number every four rows, and N/A errors between. Because I had only one starting value transferred over from the unadjusted debt column. To make matters worse, when I graphed it, the line with the N/A errors didn't show up.

All in fun. Anyway, when I regathered data for the ART2 adjustment, I got annual data. I used ART2 on the debt; the method is as follows:
1. Adjust the first debt value to the base year; then for each subsequent year
2. Carry forward the previous year's adjusted value, and add to it the new debt after adjusting for inflation to the base year. (See the May 9 post for details.)

For inflation adjustment of Disposable Personal Income, a flow, I used the standard "surreal" calculation; refer to the May 8 post for more.

Because I am using two different inflation adjustment calculations, the adjustment is not lost when I divide the adjusted debt value by the adjusted income number.

Here is a peek at the spreadsheet:



Here's how my graph turned out:

Graph #4: The "Erosion of Debt" Is Shown in Pink

The blue line shows debt relative to income, in current dollars (like Graph #2 above). The red line shows debt relative to income, in dollars of constant purchasing power, 2011 dollars. The pink area (above the blue line) shows the purchasing power eroded by inflation.

Note that the most rapid erosion occurred during the Great Inflation of 1965-1984. Let's make it twenty years, 1965-1985. That's the period where the unadjusted blue line shows no increase in debt, or what people think of as no increase in debt because the blue line runs "flat" for those years.

For the record, the GDP deflator (base year 2005) for 1965 has the value 19.934, and for 1985 has the value 61.624. In other words, prices more than tripled during that twenty-year period. That's what it took to erode enough debt to keep the blue line flat.


LINK: The Google Docs Spreadsheet for this post.