A little constructive push back on Thursday's open letter to Paul Krugman got me thinking; "how would the professor respond, were my article to find its way to his computer screen? How do I know government debt matters—even when it's owed to ourselves—when a Nobel economist, and others, say it doesn't?" (Notwithstanding the confirmation from—in my view—more credible economists)
So I pondered further:
Krugman maintains that "families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation." When he says "all they need to do is ensure that debt grows more slowly than their tax base", he's concerned with what, in mortgage application terms, would be your debt-(service)-to-income ratio (DTI). You could have outstanding debt that exceeds 100% of your annual income, but as long as the payment on that debt amounts to say a fourth of your income, and you have a steady job and a good credit score, you'd be good to go with a new mortgage—provided the new payment isn't so large as to throw your DTI too far out of whack. And his point regarding the WWII debt never being repaid is of course factually incorrect—all of the original debt has long been repaid. It essentially equates to a family refinancing mortgage after mortgage, in perpetuity, on a home that gets passed from generation to generation. Thus, in that respect, there's no distinction; whether we're talking a family or a government, all either needs to do is ensure that its debt grows more slowly than its income.
Now do you feel better—knowing that as long as the economy grows faster than the rate of government borrowing we're safe? I didn't think so. As you know, recessions happen. And during recessions tax receipts decline. And during recessions politicians borrow and spend heavily (there'll be no suffering on their watch)—the debt's risen 50% in four years because President Obama inherited the worst recession in a century, or so the story goes. But, thanks to lower interest rates, the actual debt service has barely budged during the same time period. I'm reminded of the mid-2000s homeowner who was able to refinance, cash out a chunk of equity, and keep his monthly payment roughly the same. Those mortgage investors of yesterday—just like financial markets (lending to Uncle Sam) of today—were willing to lend at very low interest rates. And as we know, alas, that didn't turn out so well. I fear the professor is taking an awful lot for granted.
Now let's consider an example where Krugman—in stating that governments need to ensure that their debt (regardless of who owns it) grows more slowly than their tax base—was right on the money (or, perhaps, defeats his own argument). That would be Italy—another country whose debt is largely owned by its people. As you know, Italy is in a bit of a pickle. Clearly, its economy has not kept pace with its rate of borrowing. And why would that be? Is it all about the recession? Maybe. But recessions—some harsher than others—come and go. And they tend to deal the heaviest blows to those who chose not to get their fiscal houses in order during the preceding expansion. Krugman likes to lever Keynes's statement, "the boom, not the slump, is the right time for austerity" —the problem being, politicians (and too many economists) are great slump-Keynesians, but they're terrible boom-Keynesians. So do you think maybe that's Italy's problem? That it's all about easy-money leading to easy-living? And that easy-living can be addicting (hence no boom-Keynesianism)? And that an addiction to easy-living leads to a decline in productivity? And that a decline in productivity leads to a weak economy? And that a weak economy leads to less tax revenue? And that less tax revenue leads to more borrowing? And that more borrowing leads to less investor confidence? And that less investor confidence leads to higher interest rates? And, finally, as the old debt comes due, higher interest rates incite panic as the government can no longer sustain its debt service obligations. That's when investors (natives even*) flee, and the government is forced, at last, to take austere measures. Which means to shrink itself to an affordable size—while, in the process, exacting the unavoidable pain of withdrawal onto its people—in the hopes of emerging some years later, lean and productive. And remaining that way until its children become Keynesians.
*But financial officials have become jittery about the possibility that Italians may stop buying this debt, and instead become more like Greeks and send their hard-earned savings abroad. —from the NY Times article linked above.
So perhaps, rather than criticizing Krugman, we should be thanking him for enlightening us to the fact that when a nation's debt—regardless of who owns it—grows faster than its income, it's got problems. But do you suppose the professor would appreciate our appreciativeness? Surely not. He would entirely reject the notion that Italy's predicament stems from the manner of activities (over-spending, cronyism, etc.) endemic to government-dominated economies. He blames its creditors for forcing reform at a time when they should be opening the floodgates—as well as the lack of its own printing press. To believe otherwise would be an outright betrayal of the Keynesian ethos...