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|
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.