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Something to keep in mind as Washington debates the sequester: US publicly held debt is roughly 74% of GDP. Gross debt, including money owed to other parts of the government such as Social Security trust funds, is 105% of GDP. Does either number suggest a tipping point is at hand, that the US debt situation is nearing crisis? One well known study puts the red line at 90%. Now another study, this one from economists David Greenlaw, James Hamilton, Peter Hooper, and Frederic Mishkin, concludes even lower levels of debt are risky:
Countries with high debt loads are vulnerable to an adverse feedback loop in which doubts by lenders lead to higher sovereign interest rates which in turn make the debt problems more severe. We analyze the recent experience of advanced economies using both econometric methods and case studies and conclude that countries with debt above 80% of GDP and persistent current-account deficits are vulnerable to a rapid fiscal deterioration as a result of these tipping-point dynamics. Such feedback is left out of current long-term U.S. budget projections and could make it much more difficult for the U.S. to maintain a sustainable budget course.
The study, just presented at a monetary policy conference in Manhattan, has already drawn a couple of critiques. Federal Reserve Governor Jerome Powell isn’t so alarmed, pointing out that unlike many nations that ran into debt troubles, the US borrows in its own currency. “There is almost certainly a level of debt at which the United States would be at risk of an interest rate spike. However, we should expect that level to be substantially above one identified based on the experience of smaller euro-zone nations.”
Eric Rosengren, president of the Boston Fed, clips the Greenlaw-Hamilton-Hooper-Mishkin model as too simple. Among the important variables it ignores are a) the financial strength of the banking sector, b) political stability, c) the level of unfunded pension liabilities to GDP, and d) demographics such as the age and education. Rosengren: “While this is not an exhaustive list of omitted variables, it does highlight that such a pared-down model may ignore important drivers of tipping points.”
So where is the tipping point? Who knows. Cross-country comparisons are always tricky, as Rosengren’s analysis suggests. And the fact that the US borrows in its own currency, which is also the world’s reserve currency, makes it unique in a critical way. But as Powell concludes, wherever the tipping point is, “we are clearly getting closer to it, and the costs of misestimating its location are enormous and one-sided. The benefits to long-term fiscal consolidation–conducted at the right pace, and without jeopardizing the near-term economic recovery–would be substantial.” A good start: Getting the 10-year debt forecast on a downward trajectory.
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