Saturday, July 2, 2016

Real Growth versus Inflation

Syll links to Mankiw who links to a PDF by Alesina and Ardagna, who write:

As far as reduction of large public debts, the lesson from history is reasonably optimistic. Large debt/GDP ratios have been cut relatively rapidly by sustained growth. This was the case of post–World War II public debts in belligerent countries; it was also the case of the United States in the 1990s when without virtually any increase in tax rates or significant spending cuts, a large deficit turned into a large surplus... However, it would probably be too optimistic to expect another decade like the 1990s ahead of us; that kind of sustained growth would certainly do a lot to reduce the debt/GDP ratio, but the lower growth we will most likely experience will do much less. Inflation also has the effect of chipping away the real value of the debt, but it may be a medicine worse than the disease. While a period of controlled and moderate inflation would have the potential to reduce the real value of outstanding debt, pursuing such a strategy would

At that point the paragraph turns to garbage. Actually it's all garbage as it ignores private debt. But it got me thinking about debt and GDP in the post–World War II period and the 1990s. And about growth versus inflation, and which of the two might have done more to reduce the debt-to-GDP ratio. So I graphed the ratio of real GDP relative to the GDP Deflator. When the line goes up, real growth is greater than inflation. When the line goes down, inflation is greater.

Graph #1: Real Growth versus Inflation

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