May 15, 2012
The supporting research
Hunt discussed several studies that illustrated the effect of debt on economic growth and the ways in which countries have historically deleveraged.
The first was a paper by Atif Mian of the University of California Berkeley and Amir Sufi of the University of Chicago. By studying the relationship between household debt and economic growth on a county-by-county basis, they concluded weaknesses in household balance sheets and declining housing prices were the “primary culprit of weak economic recovery.”
Hunt cited Reinhart and Rogoff’s 2010 paper, Growth in a Time of Debt, which argued that a country’s median growth rate falls by 1% once its debt surpasses 90% of its GDP. Along the same lines, he noted a 2011 paper by Stephen G. Cecchetti and two co-authors, The Real Effects of Debt, in which they argued that an excess of debt can lead to a “disaster,” impairing a country’s ability to deliver essential services to its citizens.
To understand how countries extract themselves from overleveraged situations, Hunt discussed 2010 research from the McKinsey Global Institute. That study examined 32 highly indebted countries that faced a financial crisis. In half the cases, those countries underwent austerity programs to reduce their debt.
In the remaining cases, the countries got out of debt through high inflation, default, expanding oil production, or a postwar boom. But those incidents were “relatively rare and occurred in conditions that do not occur today in mature economies,” he said. Moreover, Hunt said that high inflation is tantamount to austerity, in that it penalizes those on fixed incomes.
Hunt said the US recovery from the Great Depression was not the result of deficit spending; he credited a surge in demand for exports of our manufacturing and agricultural products. The savings rate rose for Americans, he said, permitting them to pay off debt and propelling economic recovery.
Hunt said that econometric studies have confirmed that the multiplier on government expenditures is “very close to zero, and in fact might be slightly negative.” He said that is true for the US and for the next five largest economies in the world. Increased government spending might generate short-lived growth lasting a year or so, he said, but it also increases the size of the government sector relative to the private sector, making the economy fundamentally weaker.
Hunt concluded his talk with a quote from the 18th century philosopher David Hume, whose work, he said, sparked the Enlightenment and was studied by scholars including Adam Smith, Emanuel Kant and Albert Einstein. In a 1752 paper, Hume wrote, "When a country has mortgaged all of its future revenues, the state by necessity lapses into tranquility, languor, and impotency."
An alternative view
Hunt and I agree that reducing our nation’s debt is its greatest challenge, but we disagree as to how that can be achieved.
I am unwilling to dismiss the possibility that the US can grow its way out of its debt, and I am not persuaded by studies such as those by Reinhart and Rogoff, Cecchetti and the McKinsey Global Institute. Those studies use data from a broad cross-section of developed and emerging economies. But it is unwise to infer any implications for a specific country, as Ken Rogoff told me in a conversation I related in a previous article on this topic.
And it is particularly problematic to apply those studies to the US. Our position is unique because of the dollar’s status as the reserve currency. Because all international trade is conducted in dollars, there is an ongoing structural demand for our currency. Indeed, the value of the dollar against a trade-weighted basket of other currencies has strengthened since the onset of the financial crisis. As Europe, Japan and potentially China deal with weakness in their economies, US assets will be the investment of choice, ensuring a strong dollar and low interest rates.
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