There's a nice economics fight going on between William Galston and Paul Krugman. Galston, essentially, adopts the posture of the debt hawk, citing concerns from Carmen Reinhardt and Kenneth Rogoff that increasing debt to more than 90 percent of GDP (the U.S. won't get there for a decade) will cramp our growth. Krugman already took up the issue a few days ago:
Reinhart and Rogoff specifically cite data from the United States showing slower growth when debt was above 90 percent of GDP. But if you know the data at all, you know that so far, the only years in which US debt was above 90 was in the immediate postwar period, when growth was indeed slow — but not because of the debt burden; instead, the US was demobilizing after the war, with many women leaving the paid work force. So it's a terrible example to use.
And I suspect that much of the rest of their result reflects reverse causation: Japan had low debt and fast growth before the 90s, high debt and slow growth since, but surely we believe that Japan's financial crisis is what both slowed growth and increased debt; similarly, the onset of Eurosclerosis is what led both to slowing growth and higher debt in Europe. And here's the thing: Reinhart and Rogoff have not, as far as I can tell, made any effort to disentangle the causation here.
That suggests that high-debt levels are often symptomatic of the other, more fundamental problems -- and the responses to them. That makes sense in the U.S. today -- yesterday Neil Irwin traced the differences between bond prices and the spin that we are on the path to fiscal collapse. It may very well be that the markets lend cheaply to the U.S. (besides the flight-to-quality effect) because debt is not the cause of our economic problems but by and large exists as a symptom of them.
Krugman notes, incidentally, that the Reinhardt/Rogoff conclusion about when debt becomes a drag on growth comes from a working paper, not a fleshed study, so it will be interesting to see if the two economists expand on their work.
-- Tim Fernholz