Tuesday, October 1, 2013

Handling a discrepancy

You often see me show debt in two mismatched time series, as in this recent graph:

Graph #1: Accumulated Debt relative to the Quantity of Base Money

Here's how other people handle the mismatch:

Looks like they made it match, huh.

Well yeah that's exactly what they did: They made it match. Read the fine print below the graph. (You can click the graph to see a bigger version.) What the fine print says is, "the Historical Statistics of the United States series is scaled (down) to match the Flow of Funds data."

Their method gives a graph that doesn't raise questions the way mine does. But I think it is their scaling of given data to obtain a convenient similarity is the thing that ought to be questioned.

Two different ways of measuring debt? That doesn't bother me at all.

(Off topic, but why they always show debt relative to GDP is beyond me.)


geerussell said...

Off topic, but why they always show debt relative to GDP is beyond me.

I assume it's because looking at anything relative to GDP is convenient shorthand to get a sense of scale, though a healthy dose of skepticism is always warranted when stocks and flows are mixed.

This leaves open the question of what stock variable would be a good choice, relative to the stock of private debt, to convey information about the stability and/or sustainability of private debt. Or to put it another way (because I can never seem to considering a question without waffling on how to phrase it) upon what foundation does the "burden" of private debt rest?

The Arthurian said...

Indeed it does, geerussell. Indeed it does leave open the question. And the path to an answer begins, I think, with a clear, practical definition of debt.

Jazzbumpa said...

geerussell is right. It provides context.

National [or any other kind of] debt right now is some big scary number, while the same debt in, say, 1921, would look like an insignificant number - without context.

Though one is a stock and the other a flow, the ratio is still meaningful. GDP, interpreted as a proxy for national income, relates to the ability to service the debt.

That would also be a flow.


The Arthurian said...

"...relates to the ability to service the debt."

Except in the case of a sudden, severe recession. When the economy stops there are no flows. Only stocks.

Anyway, what if the income is, say, 100% created from new debt. Is the ability to service debt just as hearty as when only 20% of income is created from new debt? (I don't think so.)

Besides, as debt is a stock it accumulates over many years, ultimately dwarfing the annual GDP number.

It was banks and borrowers, carefully considering debt-to-income ratios, that produced the conditions of instability that created the financial crisis.