Mark Thoma on Government Debt

I was mildly surprised to read the following reaction today from the University of Oregon’s Mark Thoma (no relation :)) to S&P’s negative outlook for US debt (via Brad DeLong):

… it’s important to remember that the US debt is a promise to pay dollars, and we can print as many dollars as we want. That could be inflationary, and the inflation can undermine the real value of those bond payments and cause other problems, but that is not technically a default.

I find the sentiment disturbing. “Not technically a default”? Correct, but an abrogation of moral responsibility nonetheless. Debasing your currency simply to avoid paying less in real terms than your debtors can reasonably expect is a cynical breach of good faith. And of course it’s more than that – it represents a systematic confiscation of wealth from people who hold cash and bonds and a redistribution of that wealth to those who hold debt.

I note that Brad DeLong raises no objection. And Paul Krugman‘s views are well known –

… in 1946, the United States, having just emerged from World War II, had federal debt equal to 122 percent of G.D.P. Yet investors were relaxed, and rightly so: Over the next decade the ratio of U.S. debt to G.D.P. was cut nearly in half, easing any concerns people might have had about our ability to pay what we owed. And debt as a percentage of G.D.P. continued to fall in the decades that followed, hitting a low of 33 percent in 1981.

So how did the U.S. government manage to pay off its wartime debt? Actually, it didn’t. At the end of 1946, the federal government owed $271 billion; by the end of 1956 that figure had risen slightly, to $274 billion. The ratio of debt to G.D.P. fell not because debt went down, but because G.D.P. went up, roughly doubling in dollar terms over the course of a decade. The rise in G.D.P. in dollar terms was almost equally the result of economic growth and inflation, with both real G.D.P. and the overall level of prices rising about 40 percent from 1946 to 1956.

I am by no means an ideologue (yet) on the general question of economic stabilization, but perhaps Irwin Schiff had a point when he claimed that the only arrow in the quiver of Keynianism is inflation.

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