Are you older than debt relative to GDP?

I am.

On bringing down the debt-to-GDP ratio

 I quoted this recently. It is still on my mind:

... provided fiscal space remains ample, countries should not run larger budget surpluses to bring down the debt, but should instead allow growth to bring down debt-to-GDP ratios organically.

Countries should let economic growth "bring down debt-to-GDP ratios organically."

By "organically" I think they mean "naturally". Here's what I think they mean: Economic growth is the natural way to bring down the debt-to-GDP ratio, and that's what countries should do.

Two guys from the International Monetary Fund (IMF) wrote the thing I quoted. They must know what they are talking about, right? You'd think. 

But when has economic growth ever been rapid enough to bring down the debt-to-GDP ratio, and when has debt growth ever been slow enough to allow it?

Once, for about three years, beginning in 2009, something like that.

Benjamin Friedman (1986), page 21:

Indeed, a sufficient period of sustained rapid economic growth could readily shrink the economy's overall debt ratio back to its historical range, not by reducing the numerator but by enlarging the denominator.

Indeed, it could. But it doesn't. When are we gonna learn?

 

PS: Economic policy encourages the accumulation of debt. Maybe if we turn that around ...

I know, it's like sacrilege

Just a minor change of wording:

... let it be, let it be, let it be
Whisper words of wisdom, let it be

And when the broke and hungry people living in the world agree
There will be an answer, let it be
For though they may be parted, there is still a chance that they will see
There will be an answer, let it be

Let it be, let it be, let it be ...

 

Just a minor change. Otherwise, let it be.

 

 

Happy holidays

Economics by reflex

Out of context, from The risks of high public debt despite a low interest rate environment:

After the 2008 Global Crisis, the interest rate-growth differential (r-g) has turned negative in several economies and interest rates have remained low ever since (Teulings and Baldwin 2014). These two conditions offer strong arguments to pursue fiscal expansions to spur growth, as a negative long-run r-g implies a more sustainable public debt, and countercyclical fiscal policy is arguably more effective in a low rate environment (Blanchard 2019, Eggertsson and Summers 2016, Ubide 2016).

The article warns of problems with the view they express, which I refer to as "reflex".

Blanchard, Eggertsson, Summers, and Ubide could surely back up their reflex view.

My problem with it is that there must be something wrong with the thinking behind that view, because that same thinking has been getting us in trouble since, oh, since the 70s. 

Look at the two "strong arguments" that are presented:

• a negative long-run r-g implies a more sustainable public debt, and 
• countercyclical fiscal policy is arguably more effective in a low rate environment

Both of these are based on the assumption that "fiscal expansions to spur growth" are "effective". They are not.

After the financial crisis of 2007-08, economists paused to reflect and evaluate their thinking. That's nice. 

It seems they decided there was nothing wrong with their thinking. That's a problem. 

Their revaluation became an opportunity for them to reafffirm their views, take more entrenched positions, and expand the political divide that stretches between those positions.

If a disaster like 2007-08 doesn't cause more of a change in economic thinking than we have seen, there is little hope for improvement. And by the way, we are on the downhill slope. We need more than just a little improvement if we want any actual improvement.
 

Out of context, from  A Future with High Public Debt: Low-for-Long Is Not Low Forever:

... provided fiscal space remains ample, countries should not run larger budget surpluses to bring down the debt, but should instead allow growth to bring down debt-to-GDP ratios organically.

Yeah, absolutely, of course, sure. Except that plan no longer works. We don't get growth enough to bring down debt-to-GDP ratios. Fiscal expansion to spur growth is not effective.

Graph #1

The red line is an exponential curve -- a growth curve -- based on data for the years 1946 to 1974. The red line after 1974 shows how big the Federal debt would have been if the debt kept growing at that rate.

The blue line shows how big the Federal debt actually got. 2019 is the last year shown. The debt is even bigger now.

The plan was working in the 1950s and 60s and the early 70s.  But by the mid-70s we needed more and more and more debt. The plan became ineffective.

Graph #2

The red line on the second graph is also an exponential curve. It is based on Real GDP data for the years 1946 to 1974, same period as the first graph. The red line since 1975 shows how big Real GDP would have been if it kept growing at the rapid pace of 1946-1974. But it didn't keep up that pace. Economic growth fell behind.

The blue line shows how big Real GDP actually got. It falls behind the trend in the mid-70s. And it keeps falling farther and farther behind all the while the federal debt (shown on graph #1) is gaining on its 1946-1974 trend.

Now, Republicans tell you that the debt increase shown on graph #1 is the reason Real GDP keeps falling behind the trend. That's just bullshit. They don't know the reason. And their argument is that they could fix the problem but the other guys won't let them. That's pathetic.

And the other guys tell you that the debt increase shown on graph #1 was insufficient, and that we need the government to spend "whatever it takes" more to boost the economy. Bullshit. That plan no longer works. And they don't know the reason, either.

In fact, neither side is even looking for a reason. They're just going with what they think they know. A phrase comes to mind: When the facts change, I change my mind. I hear that phrase repeated too often. But nobody says it from the heart. They all want the "I" who changes his mind to be the other guy.

 
I'm not going to say I know, because I've not been to the future. I've not seen my plan enacted and successful. Instead of saying that, let me just say this:

Some of them think the problem is too much government debt. The rest of them think the problem is too little government debt. Between them, they consider only one thing: government debt.

The problem, however, is excessive private debt.

One more on Krippner

From the Harvard University Press, in their page on Krippner's 2012 book Capitalizing on Crisis:

In Capitalizing on Crisis, Greta Krippner traces the longer-term historical evolution that made the rise of finance possible, arguing that this development rested on a broader transformation of the U.S. economy than is suggested by the current preoccupation with financial speculation.

Krippner argues that state policies that created conditions conducive to financialization allowed the state to avoid a series of economic, social, and political dilemmas that confronted policymakers as postwar prosperity stalled beginning in the late 1960s and 1970s. In this regard, the financialization of the economy was not a deliberate outcome sought by policymakers, but rather an inadvertent result of the state’s attempts to solve other problems.

 

• "a broader transformation" -- Yes. So de-financialization will require more reversals of policy that anyone recognizes.
  
  
• "beginning in the late 1960s and 1970s" -- Sounds right to me. Except I think the slowing of prosperity in the late 1960s was itself a result of the expansion of finance in the 1950s and early '60s (and maybe since the Civil War, though I'm not ready to make that argument).
  
  
• "not a deliberate outcome sought by policymakers" -- I've not read the book, but I agree with this conclusion. These days everybody thinks of government as the bad guy. God, that's tiresome. What I think is that policy was  not effective (and had unintended consequences, per Krippner) because policymakers misunderstood (and continue to misunderstand) the problem. Vested interests interfere with understanding, and skew outcomes in unsustainable directions.
  

Krippner's Figure 6

Source: The financialization of the American economy by Greta R. Krippner

"Krippner mistakes a period of high interest rates for a reorientation of nonfinancial corporations to financial profits."

One more time, just quickly.

According to JW Mason, Krippner "mistakes a general rise in interest rates for a change in the activities of nonfinancial businesses."

So my question is: Does it look to you like the rise -- and the fall -- of interest rates explains the change in activities of nonfinancial business shown in blue on this graph?

Graph #1: Interest Received as a % of Interest Paid (NCB)
and the 10-year Treasury Rate

My answer: Hell no!

Krippner, Mason, and Nonfinancial Corporate Business

In Corporate cashflows, 1960-2016 JW Mason writes:

It is simply not the case that nonfinancial corporations in the aggregate have turned themselves into hedge funds – have replaced profits from operations with income from financial assets. The Greta Krippner article that seems to be the most influential version of this claim is a perfect example of the dangers of focusing on one piece of the cashflow picture in isolation. She looks at financial income received by corporations but ignores financial payments made by corporations (mostly interest in both cases). So as shown in Figure 3, she mistakes a general rise in interest rates for a change in the activities of nonfinancial businesses.

Figure 3. Because she focuses on the heavy black segment in isolation,
Krippner mistakes a period of high interest rates for a reorientation
of nonfinancial corporations to financial profits.

Mason rejects the view that nonfinancial corporations "replaced profits from operations with income from financial assets". It troubles me that he does not address the slowdown of output growth that would result from such a change. It irks me that he ignores the economic slowdown that occurred in the 1970s. However, my purpose here, like his, is to consider the financial side of the economy.

Mason shows a graph comparing interest flows to interest rates and declares that Krippner "mistakes a period of high interest rates for a reorientation of nonfinancial corporations to financial profits."

That is not only a challenge to Krippner. It challenges the whole focus of my thinking. So I looked at interest income relative to interest cost. For nonfinancial business, if the ratio increases, that's financialization.

Graph #1: Interest Received as a Percent of Interest Paid
for Nonfinancial Corporate Business

The ratio runs flat in the 1950s and shows just a little increase in the '60s. In the 1970s there is a massive increase of interest income, relative to interest cost. After the 1970s slow increase again, to 2006. This graph shows increasing financialization.

And let me suggest that the financial crisis was the economy's way of trying to solve the problem of excessive financialization.

 

Interest rates trended downhill since 1981. Neither my graph nor Mason's supports his view that "a general rise [and fall] in interest rates" explains the flows of interest in the nonfinancial corporate business sector. 

In a follow-up post, Mason says

it’s true there is a rise in interest income from the 1960s through the 1980s. But, as discussed in the previous post, this is outweighed by a rise in interest payments ...

His Figure 3 shows interest income and payments, but does not show the one in comparison to the other. The FRED graph shows the comparison. The FRED graph shows that the rise in interest payments did not "outweigh" the rise in interest income. It shows the opposite. It shows that from 1970 to the financial crisis, the increase of interest income far outweighed the increase in interest payments. The FRED graph shows financialization.

After 2006, the coincidentally financial crisis creates a sharp decline on both graphs. On the FRED graph, the decline continues till 2016. After 2017 the ratio rises for two years and rises sharply -- even more sharply than in the 1970s. I take this rapid increase to be financialization's recovery from the financial crisis, a recovery interrupted by the pandemic of 2020.

I do not explain the increase of the 1970s, except to say it was not caused by rising interest rates. My guess would be that there was a change in the tax code or some other policy, perhaps in the late '60s, which caused the increase. The readiness of the ratio to increase after 2017 suggests that this policy was still in effect. The decline after 2006, due to the financial crisis, was temporary. As I interpret it, that 10-year decline was not a change in trend. The decline was a reaction to the crisis, and a temporary departure from the trend. Mason seems to see the comparable decline on Figure 3 as the natural result of downtrending interest rates. But the financial crisis was not a natural event. It was the result of decades of bad policy.

Mason references the Integrated Macroeconomic Accounts in his post. I went with FRED. I'll try it his way, using the IMA "all tables in XLSX format" file. Table S.5.a shows the Nonfinancial Corporate Business data at annual frequency, in millions, 1960 to 2020:

Graph #2: Data Comparison, IMA and FRED Data

Funny how the two lines follow each other so closely except before 1970.

Funny how the IMA data shows nothing before 1960.

Funny how FRED shows the increase from near the 25% level to near 50%: roughly a doubling in a decade. IMA, though it runs a good deal higher, shows only about half a doubling during that decade.

Funny that the IMA link brings you to BEA, which is also the source of the FRED data. Ha ha.

Mason says "Krippner mistakes a period of high interest rates for a reorientation of nonfinancial corporations to financial profits." He is saying the increase that looks like financialization is really due to the increase of interest rates. He apparently assumes that the interest cost increase and the interest income increase are similar in size. They are not.

Both FRED and the IMA show definite increase of interest income relative to interest cost in the 1970s and after. This difference between income and cost has little or nothing to do with the change of interest rates, far as I can see.

The FRED data makes it easy to see the financialization of nonfinancial corporate business. It is not as easy to see that the IMA ratio shows it, because the data starts late and goes downhill. But there is the increase of the 1970s, and the increase of the 1990s, and the increase leading up to the financial crisis. Each increase peaks at a higher level than the one before, and all of them are higher than IMA's 1960 data point. That's financialization.

For both datasets, interest income increased relative to interest cost from 1970 to the financial crisis. And for both, financialization resumed with vigor after 2017. Increase of interest income relative to interest cost is a measure of financialization. I have to accept Krippner's view on this, not Mason's.