Choosing the Right Debt Measure

In an earlier post I explained that when it comes to the nation’s long-term debt problem, what matters is the size of the debt held by the public, not the gross debt, and warned that the President’s deficit commission would go seriously off track if it focused on the wrong measure.  The Center issued a new report today that explores this issue in greater depth.  Here’s the executive summary:

A call by several members of the President’s Commission on Fiscal Responsibility and Reform for the commission to focus on the federal government’s gross debt, rather than debt held by the public, is misguided and could inhibit efforts to address the nation’s long-term fiscal challenges.

Debt held by the public consists of promises to repay individuals and institutions, at home and abroad, who have loaned the federal government money to finance deficits.  Gross debt (as the term is used in the United States) includes, along with debt held by the public, intragovernmental debt — money that one part of the federal government owes to another — such as the money the Social Security Trust Funds have lent to the Treasury in years when their earmarked revenues exceeded their expenditures for benefits and other costs.

The interest of some commissioners in gross debt stems at least partly from an analysis of 44 countries that, they believe, suggests that high levels of gross debt inhibit economic growth.  In a widely cited article, University of Maryland professor Carmen M. Reinhart — who testified to the commission on May 26 — and Harvard professor Kenneth Rogoff concluded that debt-to-GDP ratios of 90 percent or more are associated with significantly slower economic growth.  Since they use gross debt as the measure of debt for the United States, and since our gross debt now equals 90 percent of GDP, the nation appears close to that “tipping point.”

But claims that gross debt (as the term is used in the United States) is an economically meaningful measure of national debt and that the United States is approaching an economic danger zone are extremely dubious for several key reasons:

• Most economists agree that debt held by the public — rather than gross debt — is the proper measure on which to focus because that’s what really affects the economy.

• Reinhart and Rogoff used a measure of debt that, for most of the countries they researched, is consistent with the standard measure of national debt that the International Monetary Fund and the Organisation for Economic Cooperation and Development use.  Although those institutions call that measure “gross debt,” it is very different from what is called gross debt in the United States because it excludes most intragovernmental debt.  The Reinhart-Rogoff data for the United States and Canada, however, differ significantly from the IMF and OECD measures because these Reinhart-Rogoff data reflect gross debt as that term is commonly used here — and thus include large amounts of intragovernmental debt, such as the money that the Social Security Trust Funds have lent to the Treasury.

This leads to two conclusions.

• First, since the gross debt measure that Reinhart and Rogoff use for countries other than the United States and Canada does not include significant amounts of intragovernmental debt, the Reinhart-Rogoff data do not allow them to reach valid conclusions about the effects of intragovernmental debt on economic growth.

• Second — and of particular note — the authors’ gross debt measure for countries other than the United States and Canada is roughly equivalent to what, in the United States, is called debt held by the public.  In both cases, the measures essentially exclude intragovernmental debt.  And by this measure, the U.S. debt-to-GDP ratio equaled 53 percent at the end of fiscal 2009 and, under current policies, will not reach 90 percent until around 2020.

Finally, while the authors argue that debt-to-GDP ratios over 90 percent are correlated with lower economic growth, they do not argue that the former causes the latter.  In fact, other experts argue that lower economic growth may cause higher debt-to-GDP ratios, rather than the other way around.

To be sure, the specter of rising debt for decades to come presents a very serious economic challenge for our nation.   But, in addressing this issue, the commission should focus on the right fiscal target — debt held by the public — rather than on a measure or target that will cause confusion and misunderstanding and does not make sound economic sense.