Follow up: Debt-to-GDP Ratio

(Follow-up to the previous post about neglected denominators.)

Often, those concerned with the rising size of the debt in the U.S. cite the increase in the most commonly used measure of a country’s ability to pay off its debt: the debt-to-GDP ratio. It takes the size of the debt, and divides by the size of the economy.

Debt-to-GDP Ratio (FRED)

This means that the ratio can be impacted by changes in two factors: the size of the debt, and the GDP. So, a rise in debt-to-GDP ratio can be the result of a high rate of growth of the debt, or a relatively lower rate of growth in GDP. Currently, we are experiencing some of both effects at the same time.

As such, there are two ways to take on the task of bringing the ratio back down. One is to attempt to slow the rate of growth of the debt; the other is to attempt to increase the rate of growth of GDP.

Part of the popular discourse about the debt is that in the long-run, the debt can become a serious problem (which is true). And those extremely concerned with such a threat argue that we need to bring the size of the debt down to lower our debt-to-GDP ratio. But there is another way to tackle the problem: employ policies to increase GDP growth! Such policies can be effective in two ways.

First, based on the ratio above, all else being equal, policies which increase the rate of GDP growth will bring down our debt-to-GDP ratio. So those who are hyper-concerned with the debt-to-GDP should focus equally on reducing the rate of growth of the numerator AND on boosting the rate of growth of the denominator. Unfortunately, this isn’t typically the case. (Cue screaming about evil government over-spending.)

Moreover, there is an indirect avenue through which a focus on GDP growth can help everyone. In a (still) depressed economy, the immediate, short-run problem is low employment and low GDP growth. And in tough times, more individuals are in need of support in the form of unemployment benefits for example. This costs the government money. So our short-run issue is having an adverse impact on our long-run issue! Getting the economy back on track through expansionary policies which hone in on GDP and employment will not only help to address our short-run problems, it will contribute to fixing our long-run debt issue by lowering government outlays on things like unemployment benefits (as GDP growth brings about more job opportunities for those out of work).

Why there is such an excited over-focus on the notion of debt I really can’t say. It’s disappointing that policy conversation about economic growth (read: immediate short-run problem) has been entirely overshadowed by this concern about the debt (read: long-run problem whose critical mass is impossible to ascertain). But, the main story is: there doesn’t have to be as much of a trade-off between addressing our short-run (economic stagnation) problems and our long-run (debt) problems – if only pundits and policy makers would focus less on the size of the debt and more on the denominator!

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