The Arithmetic of Near-term Deficits and Debt

Paul Krugman explains why another trillion dollar stimulus wouldn’t be a big deal long term and why S&P; doesn’t have a clue of what they’re talking about:

Amid all the debt hysteria, it’s worth taking a look at the actual arithmetic here — because what this arithmetic says is that the size of the deficit in the next year or two hardly matters for the US fiscal position — and in fact the size over the next decade is barely significant.

Start with interest rates. What matters for debt sustainability is the real interest rate, since what matters is keeping real debt, not nominal debt, from growing. (World War II debt never got paid off, it just eroded in real terms to the point where it was trivial). As of yesterday, the US government could lock in 30-year bonds at a real interest rate of 1.25%. That means that a trillion dollars in extra debt would mean $12.5 billion a year in additional real interest payments.

Meanwhile, the CBO estimates potential real GDP in 2021 at about $18 trillion in 2005 dollars, or around $19 trillion in 2011 dollars.

Put these together, and they say that an extra trillion in borrowing adds something like 0.07% of GDP in future debt service costs. Yes, that zero belongs there. The $4 trillion S&P; said it needed to see clocks in at less than 0.3% of GDP.

These are not, to say the least, make or break numbers. So what are we talking about here?

America does have a long-run fiscal problem, driven by the combination of rising health costs, an aging population, and the unwillingness to raise taxes to pay for the programs we already have. If we don’t come to grips with that problem, bad things will happen. But what happens to the deficit in the medium term is almost irrelevant to the question of whether our long-run finances will get under control.

Yet S&P; (and others) obsess about those medium-term numbers, without ever explaining why. Maybe they think there’s some critical level of debt — but they don’t know that. Maybe they think that fiscal austerity over the next decade will somehow guarantee good behavior further out — but that didn’t work in the 1990s. Or maybe they’re just pulling stuff out of regions I can’t mention in the Times.
The point is that while S&P; may try to give the impression that it’s just doing the math (incompetently, too!), the math doesn’t at all support its position.

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About James Crist

How do we stop America's decline? The country is in trouble and we can all feel it. Where did we go wrong? How do we fix it? We now have an auction-based government, for sale to the highest bidder. Politicians have become nothing more than corporate whores and pawns for the rich. If we want our representatives to represent us, let them get their campaign money from us, their constituents. We have to amend the constitution to get the big money out of politics.
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