Friday, December 2, 2016

Why figure inflation-adjusted debt?

I asked when is "real GDP" useful?

Investopedia said:

Economists use real GDP when they want to monitor the growth of output in an economy.

Real GDP is useful when you're looking at economic growth.


Nominal GDP, typically referred to as just GDP, uses the quantities and prices in a given time period to track the total value produced in an economy in that same span of time. Conversely, real GDP tracks the total value produced using constant prices, isolating the effect of price changes. As a result, real GDP is an accurate gauge of changes in the output level of an economy.

Real GDP removes the price changes, in order to see more clearly the changes due to greater productive capacity.


I had some fun with the idea a few posts back, when in addition to holding prices constant, I held population constant in order to see more clearly the changes due to greater productive capacity. (Yeah, I know: Economists have a measure like that already.)

But if you want to see economic growth, you definitely want to look at GDP with prices held constant. I look at debt with prices held constant for the same reason.

An increase in debt indicates that some extra spending happened. "Extra" in the sense that it couldn't have happened if some new borrowing didn't happen. The extra spending contributes to economic growth. The new borrowing adds to accumulated debt. When I'm considering economic growth, I want to look at debt with prices held constant.


Why figure inflation-adjusted debt? Because we want to know about economic growth.

People say you can look at a graph of debt relative to GDP and see that debt was "flat" before the 1980s. Yeah, you can, but it's not inflation-adjusted. So you can't look at that graph and learn anything useful about economic growth.

You can learn something harmful. You can start thinking that debt didn't grow faster than output in those days. That's harmful, because it's not true. The "flatness" we see on that graph is a result of inflation.

Do the math.

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