Debt / Economy / Fiscal policy

Economics Made Easy: Does the U.S. Have too Much Debt?

On Wednesday, January 25, Congress voted to raise the debt ceiling to allow more government spending until about May of this year. The sequester’s forced automatic spending cuts go into effect March 27th.

Debt, spending, “fiscal cliff’, budgets, etc. keep Americans on the verge of a heart attack, and many find themselves wondering: how much debt is too much? This is an important question, and the reason we have not heard the answer- we do not know it.

Fed chairman Benjamin S. Bernanke said, “Neither experience nor economic theory clearly indicates the threshold at which government debt begins to endanger prosperity and economic stability.”

Research on the subject suggests that there could be a limit; in Reinhart and Rogoff’s “This Time Is Different,” they examine financial crises across the globe from England’s fourteenth-century defaults to the current US financial crisis, and conclude that about a 90% debt-to-GDP ratio (what a country owes compared to how much it makes in a year) causes economic retractions.

Paul Krugman, a Nobel Prize winner in economics, disagrees with their findings, saying it is the other way around: slow growth causes high debt ratios. He stated in a conversation with Rep. Ron Paul that a 130% debt-to-GDP could be sustainable, and that more spending, not less is what we need to lift the US out of the current economic slump.

Economists, like Krugman, found their argument on principles of Keynesian economics (named after John Maynard Keynes); the idea that in the short run, economies are volatile and intervention can help temper the highs and lows by increasing spending during recessions and cutting spending during growth.

Keynesian thinking has been under attack since its birth. President Truman, a contemporary of Keynes, said, “Nobody can ever convince me that government can spend a dollar that it hasn’t got.” (Ironically, Truman was president during one of the highest debt-to-GDP ratios of US).

In fact the US has had debt levels up to 120% debt-to-GDP. It is also worth noting the fact that currently Japan, Italy, Portugal and Ireland all have higher debt-to-GDP ratios than the US, and Germany, UK, Canada, and France all have debt-to-GDP ratios over 80%.

But just because everyone else is doing it does not prove or justify anything.

Timing is everything, and so it is in the case of government spending. However with the nation’s leading economists unable to come to a consensus on how much debt is too much, what should be done?

The U.S. can enter into uncharted territories accruing more and more debt in the hopes of a turn around, but this is very risky plan considering rapid projected debt growth. A more plausible plan is just that – a plan.

Members of congress might have to look outside of their two-year reelection glasses and begin bipartisan legislation that curtails spending (which is just wishful thinking).

But with the sequester – a terrible plan for cutting spending–coming into effect March 27th, a chance for a budget cutting plan and reduced stress on American’s hearts just might be possible.