Friday, July 27, 2012

Marcus: Debt is a "red herring"

Unbelievable. I was thrilled to read Krugman say:

Second, a dramatic rise in household debt, which many of us now believe lies at the heart of our continuing depression.

Why he lists it "second" I do not know. But I'm glad it's on his list and near the top.

But that's not why I called this meeting. Here's Krugman's graph:

Here's what Scott Sumner had to say about it (as quoted by Marcus Nunes):

What do you see? I suppose it’s in the eye of the beholder, but I see three big debt surges: 1952-64, 1984-91, and 2000-08. The first debt surge was followed by a golden age in American history; the boom of 1965-73. The second debt surge was followed by another golden age, the boom of 1991-2007. And the third was followed by a severe recession. What was different with the third case? The Fed adopted a tight money policy that caused NGDP growth to crash, which in turn sharply raised the W/NGDP ratio. Krugman has another recent post that shows further evidence of the importance of sticky wages. Forget about debt and focus on NGDP. It’s NGDP instability that creates problems, not debt surges.

First off, Sumner identifies the "golden age" as the years 1965-1973. You can imagine I'm not happy about that, after my last few posts. Anyway, 1965 was near the *end* of the golden years, not the start of them.

Second, Sumner sees one debt surge ending in 1964 and another beginning in 1984. Between those dates was the "Great Inflation". The inflation is the reason for what appears to be a flat spot on the graph. The inflation "eroded" debt.

The growth of debt continued apace.

My StepRate function, applied to annual CMDEBT numbers from FRED, shows that the compound annual debt growth rates during Sumner's three periods were:

  • 1952-1964: 10.7%
  • 1984-1991: 10.25%
  • 2000-2008: 9.33%

During the famous flat spot of 1965-1983, the comparable rate of debt growth was 9.36%. That's near 90% of the growth rate for the 1952-1964 "debt surge" and it is higher than the growth rate for the third debt surge Sumner identifies.

There was no remission. Debt did not stop growing. It barely slowed.

Prices increased at a compound annual growth rate of 6.6% per year between 1965 and 1983, more than tripling during those years. There was no remission of debt. There was only erosion of debt because of the inflation.

Marcus misses it. He writes:

as soon as inflation begins to trend up in the second half of the 60s, the future doesn´t look so bright anymore. Households’ don´t increase indebtedness...


Households continued to borrow at very nearly the same rate during the great inflation as they did before and after it. It only looks flat on the graph, because inflation was eroding the prior, existing debt by increasing income and NGDP.

"Forget about debt," Sumner says.

With debt growing at 10% a year and real output tracking optimistically at 3.3% (according to Marcus Nunes), debt was growing three times faster than output.

"Forget about debt," Sumner says.



Woj said...

Thanks for providing data on the impact of inflation. Considering that debt growth has remained pretty stable over time, targeting low inflation should correspond to rising debt in relation to GDP. I still tend to think that relationship is more correlation than causation, but would be curious about your thoughts. Also, any thoughts on why the rate of debt growth would be so consistent over time despite changing conditions?

Shine said...

You will see how it goes better, thanks for this information.

The Arthurian said...

Woj: "Also, any thoughts on why the rate of debt growth would be so consistent over time despite changing conditions?"

Yes, Woj, one thought, belated though it is. A decline in debt growth means a decline in new borrowing, and that means economic slowdown. Policymakers respond with deficit spending and with policies that encourage more private sector borrowing. This helps bring the rate of debt growth back up to trend.

If debt growth starts to exceed trend, we see too much money growth and too much demand growth and we see inflation. Policymakers raise interest rates to discourage the growth of debt. This helps bring the rate of debt growth back down to trend.

Policymakers think economic growth is associated with credit use, so they create policies to guide and cultivate credit use. But of course credit use causes the growth of debt, and we have no policies that discourage debt accumulation, so we end up with debt growth that is "consistent over time".