Debt according to Krugman

Paul Krugman wrote an interesting piece on his blog (New York Times) about how those in Washington DC have no idea what they are talking about when in comes to debt. Although the US economy was technically going through a recovery last year, the levels of unemployment have been worringly high – 9%. However there is concern in Congress about the rising budget deficit and the need to reign in government spending.

Krugman explains that Washington isn’t just confused about the short run; it’s also confused about the long run. Those concerned about deficits portray a future where we have to pay back what we have borrowed – it is not like taking out a mortgage and struggling to paying it back. Krugman looks at government debt in two ways:

1. Although households have to pay back debt governments don’t – all they need to do is ensure that debt grows more slowly than their tax base. As the US economy grew (and the tax revenue for the government) the debt from WW II became immaterial and was never repaid – see graph below.

2. What is unique with regard to US debt is that it is not like an individual who owes debt to a bank. Essentially the US debt is money that is owed to the US themselves. Foreigners do hold a significant amount of government debt in teasury bonds but every dollar’s worth of foreign claims on the US is matched by 89 cents’ worth of US claims on foreigners. Furthermore because foreigners tend to put their assets into safe US investments, the US actually earns more from its assets abroad than it pays to foreign investors.

Nations with responsible governments willing to impose modestly higher tax rates when the situation warrants it have historically been able to live with much higher levels of debt than today’s conventional wisdom would lead you to believe. The UK has had debt exceeding 100% of GDP for 81 of the last 170 years. Keynes suggested of the need to spend your way out of recession when the UK was deeper in debt than any other adanced nation today, with the exception of Japan. Krugman states that the US doesn’t have a government that is responsible ie. willing to impose higher taxes. Debt matters BUT more government spending is needed to reduce unemployment.

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