## Tuesday, August 11, 2015

### The Inflation Adjustment of Debt

A partial re-post from 4 August. In response to Nathan Tankus.

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Let me take the Federal debt numbers, as Noah does, and look at them a little more carefully than he does. I want to look at the year-to-year change in the Federal debt. I want to look at each year's increase. That's like looking at the deficits, just as Noah wanted.

I want to remove the inflation from each year's deficit, and then add up all the deficits to see the inflation-adjusted debt. This is a necessary step, as Noah's "explosion" occurs just as the Great Inflation is coming to an end. How can we know whether the explosion Noah sees was the result of policy or an accident of inflationary numbers?

We have to look.

 Graph #5: Noah's Numbers (blue) and My Numbers (red)
The blue line on Graph #5 shows a sudden increase beginning in the early 1980s, just as Noah Smith showed. The red line shows the increase beginning around 1974, after a decline that ends around 1966. Does it matter? It might. It wouldn't be right to say the U.S. federal deficit "began to trend upward beginning around 1980".

"Real" numbers provide the better measure of growth. If you are looking at the growth of deficits, "explosive" or otherwise, you want to use the red line. Not the blue line.

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Most people will tell you that the red line should be identical to the blue line because a ratio of reals comes out the same as a ratio of nominals.

It depends how you do the math. Here's how I did the math:

1. Take the annual change in Gross Federal Debt (FRED's FYGFD) as a measure of Federal deficits.
2. Convert these deficit numbers to "real" deficits: Divide each year's deficit by that same year's GDP Deflator, and multiply the result by the Deflator value for 1947.
3. Calculate the "real" Federal debt: Start with the FYGFD value for 1947 and add to it the "real" deficit numbers for 1948-2013 as calculated in Step 2.
4. Calculate "real" GDP for Base Year 1947 by following the same method I used to calculate real deficits.
5. Plot real debt as a percent of real GDP, and nominal debt as a percent of nominal GDP.

The trick is to figure each year's inflation for that year's deficit.

My source data is from this FRED graph.

jim said...

Seems to me that the federal debt is already adjusted for inflation.
The interest on the debt follows inflation. When there is high inflation there is higher interest cost added to each years deficit. And when inflation is low less is added to the annual deficit. Right now the contribution of interest is low because inflation is low.

We can look back now and say if inflation had been lower in the past, the debt today would be lower.

So yes. there is no doubt that inflation contributed greatly to the 80's deficits. But here's the problem: the deficits contributed to GDP and inflation, too. Without deficits the 80's would probably have been one long recession with little inflation or GDP growth. The deficits were a conscious effort to maintain GDP growth.

A long recession might not have been such a bad thing. The large deficits allowed the US to side step the whole issue of what really caused the inflation. The cause was obviously the fact that the US economy had to stop consuming so much petroleum. Prior to 1971, the US economy doubled its consumption of petroleum every 10 years for nearly a century. Then in about a decade it went from that runaway expansion of consumption to an economy where per capita oil consumption was falling. The only thing that could make that transition possible in a market economy is price adjustment.

Jazzbumpa said...

I find the whole concept of inflation adjusting debt to be deeply troubling.

You end up with a "real" debt/GDP value that is greater than the real [i. e. currently factual] value. What does that even mean?

Debt is something that exists in a specific place and time, always measured in current dollars. What matters is the ability to service the debt under current conditions, at any specific time.

Inflation adjusting debt at time t(x) has to be based on accumulated inflation relative to some t(0). But your choice of t(0) - which can [and actually must] be completely arbitrary, will completely determine your adjusted value at any t(x) and therefore the difference between adjusted and unadjusted values.

Having a denominator in the mix just adds another degree of embolixment.

Just because one has the ability to perform computations does not mean that the results have any real world significance. It's very hard for me to see how this will ever lead to anything meaningful, let alone useful.

Going forward, inflation affects interest rates and [presumably] pay scales, so there is an influence on the relative burden of the debt at some chosen future date. But none of that will be known until then. Going backward, all of that has already happened and is already reflected in debt at t = now.

Cheers!
JzB

The Arthurian said...

Jazz: "I find the whole concept of inflation adjusting debt to be deeply troubling."

I think it troubles you because it doesn't point to Reagan as the main culprit. I really do.

"Debt is something that exists in a specific place and time, always measured in current dollars."

Not "always". As I have shown :)

"Just because one has the ability to perform computations does not mean that the results have any real world significance."

"Real" numbers provide the better measure of growth.

"Going forward, inflation affects interest rates ..."

Ceteris paribus. One thing at a time. If you want to see whether inflation erodes debt, you don't look at interest rates.

Jazzbumpa said...

I think it troubles you because it doesn't point to Reagan as the main culprit. I really do.

That is really insulting. Seriously. Really insulting.

Reagan was a rat who inflicted economic voodoo on the country, was crazy about deregulating, and busted unions. He went senile while in office - a personal tragedy for him and his family, and a bigger tragedy for the county. None of which has anything at all to do with the subject at hand.

It's disturbing because I can't find any perspective from which it makes sense, which I though my comment made pretty clear.

Not "always". As I have shown :)

Sorry, I missed it. Could you point me to where you did that?

"Real" numbers provide the better measure of growth.

OK - but we are not talking about growth.

If you want to see whether inflation erodes debt, you don't look at interest rates.

I never suggested that you should. But interest rates do affect your ability to pay, and that was my point.

Cheers!
JzB

The Arthurian said...

"OK - but we are not talking about growth."

Why did rich-world deficits start exploding around 1980?

Noah's post is explicitly about the growth of debt and deficits.