Tuesday, 23 April 2013


Short post: In the wake of the Reinhart and Rogoff saga, the question of the causality of the relationship between growth and debt was re-open.

I've already mentioned an article by Arin Dube that seems to establish that it is low growth that lead to high debt rather than the reverse. Today, via the Next New Deal again, I've been reading another article by Deepankar Basu confirming the causality. 

In truth, I mostly lack the mathematical skills to truly evaluate his contribution.

However, I would like to say that this analysis of data backs my own understanding of how the world works... Quoting myself, from last year:

"Following the oil crisis and wage-price inflation struggle of the 70s, western Europe, like the US, proceeded to crush the income growth of its middle class.

However, as opposed the US, it maintained a highly developed social safety net. Also it used public deficits to boost aggregated demand - Again, this is different from the USA where the boost was provided by private consumers over-leveraging themselves".

To repeat, post-70s, with the collapse of middle class earning growth and the lowering of marginal tax rates, someone had to consume and someone had to finance that consumption via debt.

In Anglo-Saxon countries, like the UK or USA, it was mostly private individuals who stacked up debt. In mainland Europe and Japan, it was mostly the state.

And, whether we're talking about the US consumer or the mainland European states, the point is that these debt loads keep on getting bigger when growth is not occurring fast enough. The main advantage of states over individuals in this situation is that some of them at least can print their own money...


  1. "Someone had to consume and someone had to finance that consumption via debt"... Why?

  2. I am glad you asked! Because, re-reading myself, I noted that I was indeed not all that clear on this point. Mostly, I meant it as a tautology:

    The GDP growth did not collapse, that's observable, even if it slowed down, despite the low earning growth for 99% of the population (also observable).

    Therefore someone was out there, consuming at least enough to maintain 'some' growth/some stability and, in the absence of a growing income stream, debt is the only substitute.

    As I said in a previous post, if, after noting that their income stagnated, instead of borrowing, the US/UK consumers had stopped spending and Europe/Japan gvts had stopped spending, we would have had a cratering of AD a lot sooner...

    So it's not 'had' in the sense of 'was physically obligated to' but in the sense of 'we can thus deduct that someone did do X'...

    Another point: Technically, if that borrowing had somehow spurred enough growth, governments debt ratio (at least) might have been better. As we note, it didn't and so they aren't.

    Hence, conclusion, without using maths and time series analysis, I too felt that the causation ran mostly from low growth to high debt rather than high debt to low growth (though, sure, repayments cannot help and must add to the morass).

    I hope it's clearer now... :)