The first thing I want to do is duplicate Krugman's graph from yesterday's post.
|Graph #1: Krugman's Graph|
|Graph #2: My version of Krugman's Graph|
Not bad. If you see differences, it is because I downloaded "annual" data from FRED, and Krugman probably used the default "quarterly" data. Both graphs show the same "face" -- a nose in the 1980s, a chin before that, a neck in the early 1960s. Even indications of eyes and hair can be seen in the graph.
Next, I want to graph the raw debt numbers (not divided by GDP) along with "real debt" numbers figured the way "real GDP" is figured:
|Graph #3: The Raw Numbers, and "Real" Debt Figured by Aggregate Debt Adjustment|
The relation between the two lines shown on Graph #3 is similar to the relation between Nominal GDP and Real GDP, which you have probably seen many times. The two lines cross in 2005, because the price deflator used for the conversion has 2005 as its base year. The red line is higher than the blue in the years before 2005, and the blue line is higher in the years after 2005.
Suppose you wanted to use this graph to learn something about inflation's ability to "erode" debt. After all, some people do call for a higher inflation target -- increased inflation -- to help reduce the burden of debt.
But in 2005 the lines cross. The real and nominal values are equal in 2005. In other words, in 2005 there was *no* erosion of debt, despite all the inflation we had between 1950 and 2005. That is wrong, of course. But that is what the graph shows.
It is the calculation used to figure "real" debt that is incorrect.
Next, I want to do the graph again, using the incremental inflation adjustment described in yesterday's post.
|Graph #4: The Raw Numbers, and "Real" Debt Figured by Incremental Debt Adjustment|
Here, "Real" debt is significantly higher than nominal debt at every point on the graph. The red line is higher than the blue, by the amount that debt was eroded by inflation. If you are looking to see the erosion of debt, this graph shows it. Incremental Data Adjustment (IDA) of debt shows it.
// The Google Docs Spreadsheet