Debt and Delusion

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Robert Shiller cautions against concentrating too much on particular thresholds for debt ratios.

The fundamental problem that much of the world faces today is that investors are overreacting to debt-to-GDP ratios, fearful of some magic threshold, and demanding fiscal-austerity programs too soon. They are asking governments to cut expenditure while their economies are still vulnerable. Households are running scared, so they cut expenditures as well, and businesses are being dissuaded from borrowing to finance capital expenditures.

The lesson is simple: We should worry less about debt ratios and thresholds, and more about our inability to see these indicators for the artificial - and often irrelevant - constructs that they are.

The point about too much tightening too soon is especially important. The idea of fixed thresholds--debt is safe just below 90% of GDP and dangerous just above--is artificial and obviously wrong. On the other hand, the US is right to worry a lot about long-term debt projections--not because these cross some magic threshold, but because the ratio is already high by historical standards and is expected to keep on rising indefinitely. This, rather than debt in excess of 90% of GDP, or 110%, or whatever, is what makes the fiscal position unsustainable. There is time to fix the problem, and doing too much too soon will make matters worse. But that does not mean you ignore it.

Still, Shiller's point is well taken. He is always worth reading.

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