November 6, 2012
Depending on your political leanings, you’re likely to align yourself with one of two views of the economy. Either you believe our debt is the greatest crisis we face and deficit reduction should be a national priority, or you advocate increased government spending – and the additional debt that comes with it – to stimulate growth.
This debate is the central conflict that, if we can settle it, will shape our economic future, and finding a middle ground seems all but impossible. But such a compromise could be the key to finding policies both sides are willing to enact that can revive our economy.
Last week I spoke with Lacy Hunt, an unequivocal member of the deficit-reduction camp. Hunt defended – as persuasively as few others can – the need to address our fiscal imbalances. But equally respected economists are advocating for the other extreme, and he shares some common ground with them.
Hunt is an internationally respected economist and the executive vice president of Hoisington Investment Management, a Texas-based fixed-income management firm.
I’ll look why this issue is so pivotal and examine the arguments put forth by both sides of the debate. I’ll also highlight those points where there is a consensus – and possible seeds of a compromise.
The bang point and its dissenters
Our ability to incur more debt has limits, and much of the debate centers on determining where that limit may fall.
In our conversation, Hunt said we’ve already surpassed the point beyond which debt constrains economic growth. He cited a number of econometric studies, the most prominent of those being two papers by Carmen Reinhart and Ken Rogoff, Debt and Growth Revisited and Growth in a Time of Debt. Using data from 44 countries over the past two centuries, those studies showed that once a country’s debt-to-GDP ratio exceeds 90%, economic growth slows by about 1% per year. The 90% threshold has been widely cited as a danger zone for the US, and Hunt agrees about that figure’s significance.
The debt-to-GDP ratio for the US is just over 100%, according to OECD data, Hunt said.
At some point, the cost of servicing a country’s debt becomes intolerable. Credit markets calcify and the “bang” point (a term Reinhart and Rogoff coined) is reached; default is the only option. The bang point goes by other names – the fiscal limit, the Keynesian endgame, and the Cochrane condition – but, whatever you call it, it’s a point of indebtedness from which a country cannot escape.
Nobody knows when a country will hit its bang point, but considerable research has examined the path leading up to it.
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