Saturday, June 23, 2012

By the numbers (2): History is different

Debt Relative to GDP, Nonny's graph from yesterday:

Graph #1: Total Debt as a Percent of GDP

Nonny's graph is duplicated as the red line in Graph #2 below. In blue, Graph #2 shows inflation-adjusted debt relative to inflation-adjusted GDP:

Graph #2: TCMDO/GDP and Real Debt / Real GDP

The first thing to notice is that the red and blue lines are not identical. Inflation does not "come out in the wash". This is because there are two different calculations for the inflation adjustment. That is because total debt at any given point includes debt from previous years when the price level was lower. GDP does not include production from previous years.

The second thing to notice is that most of the separation between the red and blue lines occurs during the Great Inflation of 1965-1984. So, intuitively, the graph makes sense.

Third, the two lines start at the same level. This is because we don't have information on earlier years, so no inflation adjustment can be done on prior debt.

Finally, note that the blue region above the red is a measure of "the erosion of debt by inflation". Observe the period from 1966 to 1991. During this period, the blue growth of debt was very nearly as rapid as in the years after 2000, and for twice as long or more. This rapid blue period includes basically the entire "Great Inflation" when the red debt was flat, plus the rising red debt of the Reagan years, plus part of the slowdown in debt growth after 1986.

When we take the erosion of debt into account, there is no flat spot during the Great Inflation. When we take erosion into account, there is no unusual increase between 1980 and 1986. When we take erosion into account, history is different.

// The Google Docs spreadsheet

// See also Debt and Inflation (4): Recalculating

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