Saturday, August 18, 2012

On Erosion (4): Erosion and De-rosion

Now, a look at real debt relative to real GDP, where each year's addition to debt is inflation-adjusted separately, based on that year's price level:

Graph #1: Incrementally Adjusted Real Debt Makes Erosion Visible
The blue line is the same as Krugman presented, from earlier in this series. You can still see the face in it -- the nose, the chin, the forehead. CMDEBT relative to GDP, expressed as a percent, straight out of St. Louis. Nominal divided by nominal.

The red line is real CMDEBT divided by real GDP, where each year's addition to debt is adjusted for inflation incrementally, as opposed to the way real GDP is figured. The red line runs higher than the blue because inflation erodes debt. This graph shows it.

It is a simple matter now to visualize the erosion of debt. One can see it by looking at the nominal value, relative to the incremental real value, or the blue line as a percent of the red line from the above graph.

Graph #2: The Erosion of Debt by Inflation
The 1965-1983 decline is striking. That decline occurred during the Great Inflation.

The post-1983 increase suggests that either we used too much debt, or prices didn't go up enough in the past 30 years. Only one of those possibilities makes sense to me. It cannot be that prices did not go up enough.

It must be that we used too much debt.

// The Google Docs Spreadsheet

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