Balance the Budget?

When experts look at how healthy a country's finances are, they tend to look at what's called the public debt-to-GDP ratio rather than the size of one year's deficit. The IMF, and many others, tend to define "healthy" as anything below a 60% debt-to-GDP ratio.

From an academic standpoint, it's an appropriate measurement of debt burden because it accounts for total, not just recent, debt accumulation, and it weighs that burden against the size of the country's economy. From a political standpoint, it's not a very visceral statistic. Nobody's going to slap bumperstickers on their cars that say "Recalibrate that Ratio" or "59 or Bust!" So the easier message is "Balance the Budget."

Robert Samuelson makes a similar point in his column today. But then he writes this:

To stabilize debt to GDP, you have to aim much lower than the target in good times, meaning that you should balance the budget (or run modest surpluses) after the economy has recovered from recessions.

Interestingly, Europe's experience discredits debt-to-GDP targets. The 16 countries using the euro were supposed to adhere to a debt target of 60 percent of GDP. Before the financial crisis, the target was widely breached. From 2003 to 2007, Germany's debt averaged 66 percent of GDP, France's 64 percent and Italy's 105 percent of GDP. Once the crisis hit, debt-to-GDP ratios jumped; by 2009, they were 73 percent for Germany, 78 percent for France and 116 percent for Italy.

If most of the countries who are in trouble today blew past the 60 percent target, that impugns the countries rather than the target, right? In fact, it might even be an argument for the target as a valuable indicator of financial health.

Think of it this way: say I'm a teacher and I say students have to get to class 10 minutes early to help them concentrate and do well on the final exam. Most of the class flaunts that rule and half the students fail the final. Does my classroom's experience "discredit" the 10-minutes-early rule? Not really. It means my students were recalcitrant and I did a poor job enforcing. It might even suggest the rule should be employed more strictly next semester. But that's not a reason to give it up.

While Samuelson is absolutely right that (1) "balance the budget" is a clearer (if unrealistic) political frame than "stabilize the debt ratio" and (2) we should aim lower than the target in good economic times, it's not fair to argue that Europe's experience disputes the debt/GDP statistic.