Monday, November 11, 2013

Public and Private National Debt—and Other Inconvenient Truths

The recent financial crisis and the Great Recession that followed have placed great stress on a number of cherished economic beliefs. Unfortunately—for the world—economists have repeatedly been found to have cherished faulty conclusions. Increased scrutiny has suggested that economists have encouraged a number of counterproductive policies that have caused great harm. 

One of the pillars of economic dogma that fell involved the effect of a rise in the minimum wage. Once thought to be unequivocally a bad idea for job growth, it has now been deemed too difficult to call based on historical data, but there is a growing consensus that modest growth in the minimum wage can actually be a good thing.

There was general agreement among most European policy makers that the effect of government spending cuts associated with austerity policies would be small when it came to economic growth. The various experiments forced on helpless countries generated the demonstration that the effects of such budget cuts were in fact rather large.

One of the economic studies that helped underpin the austerity policies was a study that concluded public debt greater than 90% of GDP was a threat to economic growth. It turned out that this conclusion was based on biased selection of data and numerical errors.

A recent article in The Economist picks up on this latter discovery and moves economic focus in a new direction.

"Throughout the euro crisis, tough austerity programmes have been aimed at tackling sovereign debt. That German-inspired focus is badly misplaced."

The latest theory has suggested that a nation’s private debt could be more injurious than its public debt.

"High private debt is more detrimental to growth than high public debt, according to recent research by the IMF. Indeed the IMF study finds that excessive sovereign debt reduces growth only when household and corporate sectors are heavily indebted too."

A criterion is cited to provide assistance in determining which countries are misbehaving.

"Figuring out the point at which debt becomes excessive is not an exact science. The European Commission, which now has the job of monitoring any emerging macroeconomic imbalances, uses a figure of 160% of GDP for private debt—what households and non-financial companies owe in the form of loans and debt securities such as corporate bonds. That looks conservative: it happens to be the prevailing level in both America and the euro area as a whole."

This interesting chart is provided to assist the curious.

The US and the Euro area as a whole seem to be in reasonably good shape according to this model. Curiously, Italy, often thought of as an economic basket-case, appears to be in almost as good shape as the austere Germans.

Stay tuned for the next rendering of economic prognostications.

An article in The Economist addressing the growth of household debt in Asia produced an interesting chart.

It would seem the US citizens have performed well in reducing their outstanding debts over recent years. Hopefully, that is, in fact, a good thing.

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