AUSTIN – In a recent commentary for the Financial Times, Martin Wolf trots out the specter of a “public-debt disaster,” that recurrent staple of bond-market chatter. The essence of his argument is that since debt-to-GDP ratios are high, and eminent authorities are alarmed, “fiscal crises” in the form of debt defaults or inflation “loom.” And that means something must be done.
While Wolf does not say explicitly what that something is, “painful fiscal choices seem to lie ahead.” Cue the chorus calling for cuts to Social Security and Medicare in the United States, and to the National Health Service in the United Kingdom.
To bolster his argument, Wolf revisits an equation relating real (inflation-adjusted) interest rates, real growth rates, the “primary” budget deficit or surplus (net of interest payments on public debt), and the debt-to-GDP ratio. It is a familiar device, first offered up in a 1980s working paper by Olivier Blanchard, then at MIT. I analyzed it in depth for the Levy Economics Institute in 2011, and Blanchard recently revisited it for his blog, with this conclusion: “If markets are right about long real rates, public debt ratios will increase for some time. We must make sure that they do not explode.”
Since nobody likes explosions, let us agree with Wolf that “the most important point is that the debt must not grow explosively,” and also that “a particular debt ratio cannot be defined as unsustainable.” The second point is a nod at Carmen M. Reinhart and Kenneth Rogoff, both of Harvard, whose once-famous 90% debt-to-GDP threshold has long been exceeded in many countries without blowing anything up.
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