Monday, October 8, 2012

Three Decades (and an Update)


When there is too much debt, it is necessary to reduce debt. In an environment where everything is growing, it is possible to reduce debt simply by having debt grow more slowly. This is what happened in the 1980s, after about 1986.

When there is not too much debt, the economy is able to grow with vigor. This is what happened in the 1990s. The economy grew faster. And debt started growing faster again -- just as fast as GDP.

When debt grows, it accumulates. The cost of debt -- interest and principal combined -- increases. Eventually, this cost becomes too much, and the economy cannot grow. This is what happened in the 2000s.

Graph #1: The Growth of Debt (blue) and the Growth of Output (red)

Debt growth is always higher than real economic growth, except at the very end.

For most of the 1980s, the growth gap between the two lines was getting smaller. For most of the 1990s, the growth gap remained small. After the 1990s, the growth gap increased.

In the '80s, the growth gap narrowed as debt growth fell. In the '90s, the growth gap did not change, because the growth rates matched. In the 2000s, the growth gap widened because output growth slowed.

Output growth slowed when debt became excessive.

//UPDATE:

At Jazzbumpa's suggestion, I changed the red line to show Nominal GDP (Graph #2):

Graph #2: The Growth of Debt (blue) and the Growth of Nominal GDP (red)

The same analysis applies:

For most of the 1980s, the growth gap between the two lines was getting smaller. For most of the 1990s, the growth gap remained small. After the 1990s, the growth gap increased.

The reduction of debt growth in the 1980s created slack in the financial system. This slack let the economy rise like a helium balloon in the 1990s. After a few years debt growth had taken up all of the slack, and economic growth suffered as a result.

4 comments:

Jazzbumpa said...

Your observations suggest a hypothesis: "Output growth slowed when debt became excessive."

This, in turn, suggests a couple of couple of corollaries:
1) There is a non-excessive amount of debt. Let's call it "just right."
2) Below the "just right" amount, there might also be "not enough."

Actually, there is a lower level hypothesis, to which yours is corrolary: That there is a functional relationship between debt and growth, in which growth is the dependent variable.

This is a directly testable hypothesis.

Yours requires some elaboration to be testable. "Too much" needs to be quantized, probably relative to some measure of ability to pay: personal wealth or income, or GDP.

You may well be onto something here. What is your next step?

Cheers!
JzB

Jazzbumpa said...

GDPC1 is in constant 2005 dollars. I think you should use the GDP series.

JzB

The Arthurian said...

Thanks Jazz.

I DEFINITELY accept the two corollaries you enumerate.

I think you understand "testable hypotheses" better than I do. I could use some help with that, if you're willing.

For me, "too much" debt is defined by the response of the economy. And I'm sure it is related to long cycles.

I updated the post, replaced GDPC1 with nominal GDP on a second graph. Good idea.

Jazzbumpa said...

Art -

By testable hypothesis I mean check to see how the ideas hold up against historical data. I'm definitely willing to participate.

I started looking at the relationship between debt and growth. (What I see as the lower level hypothesis.) It is definitely there, and definitely positive. The slope and R^2 are both variable over time, which fits your theory, I think. Burning question for me is - which is the dependent variable. I'll get a post up today or tomorrow.

Cheers!
JzB