Talking about public debt: dumb, dumber and dumbest

As austerity is all the rage among policy making elites I thought it would be a good time to talk about ways of measuring public debt.  Here I will deal with the dumb way, the dumber way and dumbest way to talk about debt.

The usual way to talk about public debt is to express it as a ratio of debt to GDP.  The first problem wit this metric, however, is that there is no agreement between economists on what is a stable level of debt to GDP.  There does seem to be some agreement that sovereign governments (currency sovereigns) with their own nationally issued currency do not face any hard boundary on the debt to GDP ratio.  They may be output constrained, but they are never money (debt) constrained.  It is also generally agreed that subservient governments (those without central banks and their own currency, i.e., a province, a state, a member of the EMU) are money (debt) constrained.  Although, even here, there is no agreement on debt to GDP ratios.  the EU and IMF have chosen 120% as the health threshold for Greece.  None of the Canadian provinces are  even close to that level even if you throw in federal debt.  But then why would you throw in federal debt?  The federal government can always honour its Canadian dollar denominated debt obligations.

Lastly, when talking about GDP it can be measured quarterly, yearly or by the decade.  If I measured Canada’s debt to quarterly GDP I would, by definition, quadruple the ratio.  Similarly, if I measured debt as a percent of GDP per decade, I could reduce the ratio by more than a factor of ten (assuming the economy grows).

So which one do we choose?  If we think of GDP as an income stream it probably makes more sense to measure debt as ratio of GDP over 10 to 20 years (or maybe based on the term structure of the public debt).

Think about it.  When you go to bank for a mortgage they try to figure out what your income will likely be over the amortization period not one year, or one quarter.  So debt to annual GDP ratios are a pretty dumb way to talk about public debt.

Take heart though, there even dumber ways to talk about public debt.  Unfortunately for Newfoundland and Labrador, their premier has decided to have the dumber conversation.  The Globe reports that:

She [ms Dunderdale] also wants to bring down per capita debt – the highest in Canada – to the national average within 10 years.

I appreciate it is hard to sell soft-austerity to what was once a have-not province, that went without for a generation or more, only to be swamped by a tsunami of oil and gas profits.  Nonetheless, talking about debt per capita while not the dumbest conversation to have is dumber than it ought to be.

Measuring debt per capita is even more meaningless than debt per annual GDP.  Here is why.  First, demographic composition.  As Lana Payne, head of the Newfoundland and Labrador Federation of Labour, has pointed out, population increases can be driven by a growth in the economically inactive population.  Your debt per capita ratio goes down but your debt per economically active has gone-up.

Second, and somewhat linked to first, debt per capita says nothing about income.  What matters in Newfoundland (or anywhere else) is debt as a percent of GDP (subject to the limits discussed above).  Dunderdale is acting as though that when a family makes a mortgage application it is accepted or declined based on the size of the family and not household income.  This is disingenuous.  Ms Dunderdale knows better and so does her finance minister and so do the economists working for them.

The only dumber way, the dumbest way, is to talk about absolute public debt in nominal terms.

The real issue about public debt and budget deficits is what they are being used for and the capacity of the economy to absorb those investments.  The federal government, Ontario and Newfoundland and Labrador should be having that conversation.  Instead they are rehearsing respectable dogma.

Should Ontario Become an Independent Country?

Ok just forget how crazy the question sounds.  The recent wrangling between Ontario and Alberta over the value of the Canadian dollar, oil output and the decline of manufacturing in Ontario (and other provinces east of Ontario) raises some reasonable questions about the Canadian monetary and fiscal union, aka the Confederation of Canada, aka, British North America, aka Canada.

Critics have long argued that the Bank of Canada’s single minded attention to price stability, i.e., inflation, and to a single policy instrument, i.e., the interest rate, was both too crude and too cruel.  Too cruel because it makes unemployment the site of dynamic economic dynamic adjustment and too crude because it is both geographically insensitive and structurally daft.

Here I will put the cruel to one side and consider the crude.  Interest rate adjustment is a crude way to attempt to manage the macro-economy.  Think about the regional dimensions.  If you exclude Western Canadian growth the beavers teeth look not nearly so sharp, or as long.  The present interest rate regime is probably too low for western Canada and too high for eastern Canada.  Suggesting that, all things being equal, the Canadian dollar is probably too high and too low.  Too low for the resource sector and too high for manufacturing.

Federal tax policy has not helped either.  The unilateral decrease in corporate income tax rates deprived the federal government of resource revenue while having little if any impact on investment in the manufacturing sector.   The west did not need a GST rebate the east did.  And to add insult to injury, the Federal government has decided to move to an austerian footing.  Again viewed through the lens of the west probably not a totally idiotic position to take (countercyclical one might say).  Viewed from the east, however, a completely counter-productive, pro-cyclical policy.

All of which raises the question if Ontario, or indeed if all of the provinces east of Manitoba, would not be better off with their own federal government and their own central bank.

O.k. time to remember how crazy the question was.  Not that crazy after all.  But it is only a sane question because macroeconomic policy (fiscal and monetary policy) is so cruel and crude.

Gordon V Jackson: the corporate tax cut myth

Apparently Stephen Gordon is having a hard time figuring out where Andrew Jackson, the chief economist for the CLC, got the bizarre idea that:

The argument for corporate income tax cuts has been that increased after-tax corporate profits would be re-invested in company operations, boosting economic growth, productivity, and jobs.

Stephen replies in the comments section:

No. That’s not the argument. At least, I’ve never heard anyone make it.

No one, ever, anywhere, has insinuated or made that argument.  Really?  To continue reading and comment click.

Stimulative austerity bearing fruit in Britain? Not. Nor globally

George Osborne was quick out of the gates with the austerity as stimulus gambit.  Which as everybody from myself to Paul Krugman predicted was going to be a flop.  Osborne has been trying to save face by arguing that his government’s austerity package saved Britain from becoming Greece  (the most disingenuous piece of clap trap coming from the other side of the Atlantic since Tony last spoke of the need to go to war in Iraq).  The bond vigilantes are not swarming in on fully sovereign countries (i.e., those with the power to go around the bond market if they so choose; see almost any post by Bill Mitchell).  Indeed, Japan has a debt to GDP of over 200% and is issuing ten year bonds with great fan fare at below 2%.

Meanwhile Cameron has been trying to save face with an alternative: namely, that it is the crisis in the Eurozone that is to blame.  As Bill Mitchell points out the Eurozone was in crisis before Cameron pushed through austerity.  That is to say, if the British economic recovery hinged on a buoyant Europe it was a silly plan.

Now some fair-minded reader might insist that neither Osborne or Cameron could have known that the crisis in Europe would go from bad to worse and they are therefore the victims of optimism but not stupidity.  Not so.  Like the Canadian Finance Minister, Osborne has been preaching austerity and public sector restructuring to all and sundry.  The problem is that the austerity gambit requires that exports do the heavy lifting in terms of dragging the domestic economy up, up and away.  But if all the countries that buy your imports are also trying to do the same then in the aggregate we all loose: a in an anchor cut loose.

Canada and Britain could have perhaps used austere means to jump start their domestic economies by free riding on a massive stimulus in the US and Continental Europe.  Again it has been clear for some time that was not going to happen.  So even if austerity could have worked its funky magic it would have been because Europe was doing stimulating fiscal stimulus.