Krugman and others have been doing a victory dance, claiming that the Reinhart-Rogoff work on the relationship between debt and growth has been repudiated. Hardly. The R&R spreadsheet error is embarrassing, but of minor consequence. The other criticisms leveled by Thomas Herndon, Michael Ash, and Robert Pollin are matters of judgment and interpretation, not definitive error.
Not surprisingly, Niall Ferguson is quite scathing in his criticism of Krugman’s gloating. Ferguson just points out the obvious. There is a limit to debt, and accumulation of too much debt leads to either default or inflation. You can’t borrow a trillion (or about 6 percent of GDP) forever, or even for a modest period, without coming a cropper.
The most interesting part of Ferguson’s analysis draws an analogy I’ve used before: between governments and Enron. (And Niall is nice, not pointing out that Krugman took Enron’s checks as an “advisor.”) What do they have in common? Hiding huge liabilities off balance sheet. Well, that’s not really correct. Governments don’t have proper balance sheets. ”Government accounting” is something of an oxymoron.
But in the main, the point holds. The debt that was on Enron’s books was only a fraction of its actual liabilities, and the official debt of the U.S. government (and most governments, for that matter) is only a fraction of its (and their) actual liabilities. Indeed, Medicare, Social Security, loan guarantees, and so on are so large compared to official debt that the U.S. government makes Ken Lay and Jeff Skilling and Andy Fastow look like petty grifters.
So debating whether debt greater than 90 percent of GDP results in a substantial reduction in growth is really a sideshow. The U.S. is around that level now (somewhat over it when all government debt is counted, somewhat under it when only debt in public hands is) — but when you tote up only Treasury bonds, notes, and bills. When you add it the off-balance sheet items, 90 percent looks like the epitome of prudence and thrift.
Of course the government has off-balance sheet assets too — like its taxing power. How do you value that? (Which is perhaps one of the reasons governments don’t keep formal balance sheets.) But that taxing power is not unlimited. What’s more, due to the deadweight costs of taxation, it is precisely using that “asset” that can be a drag on growth.
All in all, though, when you consider the true state of U.S. government finances and count all the liabilities, the academic debate over whether there is a growth threshold when debt hits 90 percent of GDP appears, well, academic.
Craig Pirrong is a Professor of Finance and Energy Markets Director of the Global Energy Management Institute at the Bauer College of Business, University of Houston. He is also author of The Street Wise Professor.