Show and Tell: A Comparison of Contexts for Debt

Today's graph shows total debt (public and private) in two contexts. In red, debt is shown relative to GDP. In blue, debt is shown relative to circulating money. The two are similar, but each has a feature not present in the other.

The commonly used context, GDP, is often described as the "size" of the economy. We can say the red line shows debt relative to the size of the economy. Economists say GDP measures "final spending". They would say the red line shows total debt relative to final spending.

The blue line shows debt relative to circulating money, the stock of money used for paying bills. This context is relevant because "the stock of money used for paying bills" is what we use to make the payments on our debts. Creating debt creates that money. Paying down debt destroys it.

You might think the debt number and the circulating-money number are equal. For the record, they are not.


The graph follows. The bullet points below the graph present half a century of comparison of debt in the two contexts. Touch, click, or hover on the bulleted text to display markups on the graph. Scroll the white window for additional bullets.

M1 Money (blue) and GDP (red) as Context for TCMDO Debt

Before the 1990s
  •  The red line is held down by the Great Inflation from the mid-1960s to the early 1980s.
  •  The blue line is not.
  •  The red line is driven up by the winding down of inflation in the 1980s.
  •  The blue line is not.
  •  The red line might have run parallel to the blue from 1960 to 1990, if not for the Great Inflation.

The 1990s
  •  The blue line falls for a few years after 1990, reducing the financial cost borne by each dollar of M1 money.
  •  The red line does not.
  •  The blue line shows great increase after 1993, as credit use drives growth in the "Goldilocks years" of the latter 1990s.
  •  The red line shows no comparable increase.
  •  The blue line provides better information regarding the improved economy of the Goldilocks years and the changes that prepared the economy to enjoy that improved economic performance.

The Onset of Crisis
  •  Coming out of the 1990s the blue line returns to its pre-1990 trend. The red does not.
  •  When the final rush to peak occurs, it occurs first in the blue.
  •  And in the race to the peak, the blue line gets there first.

Simon Wren-Lewis warns of "the danger of presenting increases in nominal terms, where any growth may just reflect inflation." This same danger arises when we use GDP as the context for debt.

GDP measures the output of a single year. Debt measures the accumulation of many years. The value of a dollar some years back is not the same as that of a dollar today. The value of debt and the value of GDP are affected differently by inflation. The dark red line shows a disturbance that just reflects inflation.

Mistaking the effects of inflation for real change is a valid and important concern. But we must beware also the danger of choosing a ratio that fails to show real changes. In the decade after 1985 there was an unusual drop in the growth of total debt and a substantial increase in the quantity of circulating money. These changes reduced the financial cost associated with using money, and opened a door to the improved economy of the latter 1990s. The blue line shows these changes. The red line does not.

GDP is a useful context variable. But as a context for debt, circulating money is as good or better.


For more on the anomaly of the 1990s, see Four Thoughts.

For more on the financial cost of money, see Estimating the Factor Cost of Money (2).

For more on inflation and debt, see Illusion, Reality, and the Growth of Debt and the PDF Measuring the erosion of debt.