Saturday, August 25, 2012

Heilbroner and Bernstein (2): Adjusting "this year's deficit" for "last year's inflation"

Woke up the next morning saying That's not right!

I think Heilbroner and Bernstein's incremental adjustment is a cheat that reduces debt by bad arithmetic.

Suppose we have an inflation that reduces our 100 debt to 90. But let's do it H&B's way, adding in this year's new debt before making the adjustment.

So, say our new addition to debt is 10. So our total before inflation is 110. And then after the inflation adjustment, ten becomes nine, so our 110 debt becomes 99.

We start with 100, add 10, adjust for inflation, and end up with 99. We end up with less debt than we started with, after adding ten. That has to be wrong. It is wrong, because we don't get to inflation-adjust this year's addition to debt for last year's inflation!

What I think it should be: Take last years accumulation of debt (100) and adjust that for last year's inflation (reducing it to 90) and then add this year's deficit (bringing accumulated debt up to 100 again. The difference isn't much, 100 instead of 99. But do it wrong every year and accumulate the differences, and it will add up. Anyway if the math is wrong, it's wrong.

As I noted previously, H&B's objective in the book (as Thayer Watkins presents it) was to minimize debt. Not to reduce debt, but to reduce the significance of debt in people's minds. It looks to me like they were willing to use bad arithmetic to do it.

I still need to check this out more rigorously.