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Home Publications Blogs Beat the Press Paul Krugman and the 90 Percent Zombie

Paul Krugman and the 90 Percent Zombie

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Wednesday, 27 February 2013 08:11

Paul Krugman is engaged in battle with the 90 percent zombie: the claim that economies go to hell when their ratio of debt to GDP exceeds 90 percent. He makes the obvious point that it is really impossible to untangle cause and effect with such a small sample. The countries that had debt to GDP ratios above 90 percent all had other major problems that likely would have impeded growth even if they had no debt.

I have written numerous times as to why this claim is beyond silly. Among other things, government can sell off assets that would substantially reduce their debt. In the old days governments used to sell off the right to collect certain taxes. We do something similar today with patent and copyright monopolies. Anyhow, if we used these routes to get our debt to GDP ratio below 90 percent, would everyone be happy?

However, to my mind, the bullet to zombie head in this story is the fact that we can easily change the debt to GDP ratio with some simple and costless debt management. If interest rates rise as projected, we would have the opportunity to buy back trillions of dollars of the debt issued in the current low interest rate environment at sharp discounts. Suppose we bought back $4 trillion in long-term debt at a price of $3 trillion because higher interest rates lowered the price of the outstanding bonds.

This would immediately chop 6 percentage points off our debt to GDP ratio. If that pushed us from 92 percent of GDP to 86 percent of GDP, is everything now hunky dory? According to the 90 percent zombie story it would be. For folks more grounded in reality this is a waste of time.

Comments (13)Add Comment
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written by liberal, February 27, 2013 8:49
We do something similar today with patent and copyright monopolies.


Really? I thought we gave those away for free, or in the case of patents a nominal fee.
Free Markets vs. Zombies
written by Robert Salzberg, February 27, 2013 8:51
If you believe in the sanity of the free market, then you can't believe in the 90 percent zombie. Why would a sane market think 80% debt is OK but 100% debt is catastrophic?

As Dr. Dean Baker has repeatedly explained in BTP, what matters more is interest paid on the debt as a percentage of GDP which is at historical lows today.

If Americans really believed in the 90% zombie than they should borrow no more than 90% of their gross income when purchasing a house.
...
written by watermelonpunch, February 27, 2013 8:53
So is this a legitimate chicken or egg question?
Or simply a red herring?
Mind the units
written by David M, February 27, 2013 9:47
My HS Physics teacher to always reminded us to remember the units when doing equations. In the case of debt (in dollars) to GDP (in dollars per year), the dollars cancel out and your left with the unit, "years". So when people talk about a 90% debt/GDP ratio, they really mean 90% of a year (328 days), which makes it sound that much more ridiculous as a unit of measurement.
I'd like to hear a pundit say, "as long as the debt to GDP ratio is less than 300 days, we're okay, but we're inching up to 325 days, so it's time to start panicking." No one would take him (sic) seriously.
...
written by skeptonomist, February 27, 2013 9:51
Countries have prospered greatly despite debt/GDP far above the "magic" 90% level. Look at Britain in the 19th century for example:

http://www.ukpublicspending.co.uk/uk_national_debt_chart.html

And the US started the prosperous post-WW II era with 120%. There was a "recession" at the end of the war, but this is really an artifact of the cessation of war production - unemployment remained very low through all the time when debt was high. And of course tax rates were highly progressive all that time.

It is mystifying how supposedly reputable economic "scientists" could believe in some of the supposed dire effects of debt itself (on interest rates as well as growth) - they must ignore history to do so.
interest rate cycles...
written by pete, February 27, 2013 10:16
I doubt whether this strategy can work, issuing a lot of long term low interest rate debt and then buying it back at discounts. Note that at that time the refinancing will be at higher rates. Seems kind of bass ackwards to what we do as homebuyers, refinancing when rates fall. It would be much better to mark the debt to market and keep the low interest rates. Clearly we need a better rule for the debt...such as if congress passes a law which requires spending and is not financed, then congress is de facto agreeing to increase the debt.
Try to get on TV
written by Brett, February 27, 2013 5:44
With psychopath Rick Santelli and explain to him that you could buy back debt at a discount when interest rates rise and see if he understands. This is an important point (showing that the debt to GDP fear-mongering is a farce), but not understood by illiterate, innumerate people of which many work at CNBC and WaPo.
@pete
written by Brett, February 27, 2013 5:48
That's the whole point. It's a numbers game -- it would do nothing to alter the interest payments we must pay on that debt. That's why it's silly to be so concerned over the debt to GDP ratio when such a number could be easily manipulated -- it's underlying economic problems that are more of concern (such as mass joblessness).
...
written by Jesse, February 27, 2013 10:48
"Suppose we bought back $4 trillion in long-term debt at a price of $3 trillion because higher interest rates lowered the price of the outstanding bonds. This would immediately chop 6 percentage points off our debt to GDP ratio. If that pushed us from 92 percent of GDP to 86 percent of GDP, is everything now hunky dory?"

What is the duration of the debt distribution? I was under the impression that quite a bit of the debt is short term.

And of course to buy this debt at a discount we would be issuing new debt at the higher rates, right?

This is a bit too clever by half. There are some ways to do this, but this is perhaps not such a good example.
Why should I bother with economics anymore?
written by Anitiderivative, February 28, 2013 2:15
Economists should be paying more attention to Amory Lovins than the neoclassical model.

Even the "progressive" EPI ignores the RMI.

Godspeed.


Basic Finance
written by Nate O, February 28, 2013 9:52
@Jesse - If you think that won't work, you must not understand how bond prices are set.

Bond prices vary inversely with interest rates. That is, when interest rates go up, bond prices fall. When interest rates fall, bond prices go up. The price of a bond is the present value of the future cash flows.

If the market rate increases above the coupon rate, the price of the bond has to drop so whoever buys it can realize capital appreciation to compensate for the lower-than-required yield.
...
written by a, February 28, 2013 2:09
"Suppose we bought back $4 trillion in long-term debt at a price of $3 trillion because higher interest rates lowered the price of the outstanding bond."

That's a good point and IMHO is worth expanding. A better metric for the numerator in the ratio debt/GDP is the present value of all cash flows (principal *and* coupon payments) that the government owes. Dean’s arbitrage of buying back debt leaves this metric unchanged, as the PVs before and after do not change; so it’s clearly (!) a better measure. As long as interest rates are stable and the government has emitted bonds with coupons at current rates, the principal is a good approximation to this metric, since the principal will be close to the PV. OTOH, when interest rates are extremely low, as they are now, so that coupon interest rates of already emitted debt tends to be higher, the PV will be higher than the principal. So I think Dean's point works against the US: looking at the numerator, the US' position is actually worse than the traditionial ratio indicates.

It's when you look at the denominator that the US comes out better. Current GDP is not the best metric, since a country whose GDP will double in five years is obviously in better shape than a country whose GDP stays stable, other things being equal. Because of the US' greater ability and willingness to increase its population, GDP has a built-in tendency to increase, more than most other developed countries.
...
written by havnaer, February 28, 2013 3:04
.."Suppose we bought back $4 trillion in long-term debt at a price of $3 trillion because higher interest rates lowered the price of the outstanding bond."

Let's take this one Keynesian step further.

Suppose we bought back $4T in long-term debt at $3T, THEN ISSUED ANOTHER $1T IN L-T DEBT.

Our Debt/GDP ratio remains unchanged but we have an extra Trillion Dollars to do stuff like, oh, hire a bunch of Long-term unemployed Americans to dig holes and bury money in them. Those extra jobs generate revenue at a multiplier (I'm told) of 1.2, so the added debt is actually paid off more quickly.

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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