Debt to GDP

Government debt as a percentage of GDP is a popular measurement to determine if a government is spending too much, with various "thresholds" given for when the debt gets too excessive. Unfortunately it is not a good measure in itself.

The first problem is with the items being measured. GDP is measured with the formula "Y = C + I + G + ( X - M )", or GDP is equal to consumption plus investment plus government spending plus exports minus imports. Although there are many criticisms of GDP the worst is that it includes government spending as a positive component.

Government spending is, at best, a transfer instead of an actual investment or consumption. A measure of the GDP that leaves that out would be "Y = C + I + X - M". But given that there’s inefficiency in the process, every government dollar spent is actually a drain on the economy. They Keynesian "multiplier effect" is a myth unsubstantiated by actual results. To measure the full effect of GDP would be to subtract government spending, giving "Y = C + I + X - M - G".

The other part of the ratio, the debt, is also a problem. The government debt is not a stationary target, but is moving, which means to get an effective measurement includes the deficits. That means government spending is on both sides of the ratio. Increasing government spending will increase both GDP and Debt, making all ratio measurements unreliable.

The second problem is that debt to GDP is used to measure a government's ability to repay the government debt. That implies that the government has a claim on the GDP of a country, which implies that the government has a claim on the whole of the wealth of a country. Any attempt to claim that wealth in an effort to pay off the debt would destroy the economy and deplete the wealth of the country.

Third, given that both parts are moving targets, an 'improving' ratio doesn't necessarily show any greater or lesser responsibility on the part of politicians. If the debt increases slower than the GDP climbs, or if the debt decreases but the GDP decreases by a smaller amount, the result is the appearance of improvement. Reverse the ratios and it gives the appearance of economic degradation. In the first half of each example, debt increased. In the second half of each example, the GDP declined. None of those are good, but two of them give the appearance of a better economy.

Fourth, the measures can be manipulated. Take a country with a debt to GDP ratio far in excess of 100%, such as 130% or higher. That country's government can use the central bank to monetize the debt and borrow money a thousand times more than owed before, such as a country that owes trillions can create quadrillions. The government can then spend the money. That would surely alter the GDP equation, with G increasing by an exponential amount while C, I, X, and M trend towards zero, leaving Y increasing while basically equaling G. Debt would also be basically equal to the newly created money, leading to a debt to GDP ratio of approximately 100%. By those who favor debt to GDP as a measure, that leads to the conclusion that the economy of that country has improved, while any objective measure would show hyperinflation and the collapse of the economy.

There really is little use in debt as a percentage of GDP. It doesn't measure what it is supposed to measure, it is very prone to manipulation, and its components aren't very as reliable as one would desire in an economic measure.

Against Milton Friedman

Upon seeing "Fear the Boom and Bust”, the Keynes versus Hayek rap video, the following email was sent to the producers of that video:

On Thu, Apr 22, 2010 at 11:39 AM, Ayn R. Key wrote:

Having Keynes versus Hayek was great. Loved the imagery of alcohol and hangover, and the reference to Tim and Ben.

Next, Hayek (or Rothbard or Mises) versus Friedman (or Fisher, where Friedman got all his ideas from) please.

I'm tired of people thinking that Chicago School Monetarists are some sort of libertarians.

The following response was forthcoming:

On Thu, Apr22, 2010 at 9:16 AM, John Papola wrote:

Thanks for the note! Explaining the differences of the two schools of thought is useful and we'll be getting to it in our extended content via interviews. It's a little too nuanced for a rap song.

Have you read Roger Garrison's "Time and Money”? There is much more in common between the Austrian theory of the business cycle and Milton's monetarism than meets the eye. If we can't call Milton a libertarian, we're doomed. I'm not big on libertarian factionalism. Compared with our opponents on the Keynes/Marx statist side, the differences between Hayek and Friedman are inconsequential in my opinion. Friedman was also very successful in moving public opinion and the profession away from Keynes. For that we should all be grateful.

Friedman, Hayek, Mises and Rothbard are all awesome in different ways.

For reasons unknown, Milton Friedman is considered to be a libertarian thinker, especially in matters economic. He is often used as an example of libertarian thinking by those who are not libertarians but wish to reference libertarians to support a point.

The problem is, Milton Friedman was a Monetarist. As pointed out, Monetarism is not the same thing as Capitalism. When compared to Keynesianism then of course it appears to be more libertarian, but that is an awfully low bar to measure against.

There are many critiques libertarians can make against Friedman, such as his relationship to Pinochet or how he instituted income tax withholding, but the most fundamental one is that he, like Irving Fisher, advocated central banking.

If Keynesians are to be considered as saying that two and two make eight, and Austrians are to be considered as saying that two and two make four, then Monetarists try to position themselves as moderates by saying that two and two make six. They may be closer than Keynesians, but they are still quite wrong. Central banking, the defining position of Monetarists, is causing yet another catastrophic collapse, and people actually are calling it libertarian? Calling it so is a gift to the statists that they couldn't even hope for.