## Friday, August 24, 2012

### Heilbroner and Bernstein (1)

It took about two hours of Google search, but I finally found somebody who inflation-adjusts debt by the incremental method, as I do in the On Erosion posts and the Measuring the erosion of debt PDF.

The "somebody" is Robert Heilbroner and Peter Bernstein, authors of the book
The Debt and the Deficits: False Alarms/Real Possibilities. I found them in an old page by Thayer Watkins of the San JosÃ© State University Economics Department: The Deficit of the Government.

Watkins reviews the techniques by which Heilbroner and Bernstein minimize the Federal debt:

First, Heilbroner and Bernstein consider how much of the Federal debt is owned by the Federal Government itself. Deducting the sale of debt to agencies of the Federal Government gives a net concept of the deficit as opposed to the gross deficit...

Second, there is no reason to limit the concept of government deficit to just the Federal Government. The state and local governments' budgets should be taken into account as well. Usually on balance the state and local governments run a surplus which offsets a major portion of the Federal deficit.

To me, these sound like agenda-driven arguments. But there is something else:

The above corrections are important but the most important conceptual innovation presented by Heilbroner and Bernstein is the correction of the debt for inflation.

Watkins presents a formula to figure the deficit from debt numbers:

(Deficit in year t) = (Debt at time t+1) - (Debt at time t)

and says,

Heilbron and Bernstein correctly note that if one wants the real (inflation adjusted) deficit the way to get it is from the above equation in which the value of the debt at time t+1 is adjusted for changes in the price level by dividing by the price index.

(Real Deficit in year t) = (Debt at time t+1)/(1+f) - (Debt at time t)

where f is the rate of inflation during year t.

I have to look at this. The inflation adjustment is not written the way I would write it. I went to bed thinking about it and woke up the next morning saying That calculation's not right!... It looks to me like he is adjusting "this year's deficit" for "last year's inflation". But I'm not sure. I have to look at it.

In the meanwhile, I am happy to see that I am not the only one who thinks that the inflation adjustment of debt must be an incremental adjustment.