Paul Krugman and the 90 Percent Zombie

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.