Why does national debt rise so sharply during a recession?
March 22, 2016 9:56 AM Subscribe
What is the relationship between the size of the national debt and GDP? Interested in the 'strength' of the variables.
English here (for context). I was reading this this morning, which says in the 'Recent History' section that the UK's national debt was just 29% of GDP in 2002. By 2007 it had reached 37%, by 2009 it stood at 56.8% and now (following section) it's up to 86.8%.
The UK experienced five successive quarters of negative growth from the second quarter of 2008 to the second quarter of 2009 (-0.2%, -1.7%, -2.2%, -1.8% and -0.3%).
I am interested in the relationship between the size of the national debt and GDP, because (as a strict non-economist), the ballooning national debt seems on the face of it to be out of all proportion to the relatively small negative GDP numbers above. I understand the during a recession the tax take goes down and government costs like social security rise, but it's the relationship that I don't follow. Is a one of those cases where one small variable is able to 'punch above its weight', so to speak (rather like carbon dioxide in the atmosphere)?
English here (for context). I was reading this this morning, which says in the 'Recent History' section that the UK's national debt was just 29% of GDP in 2002. By 2007 it had reached 37%, by 2009 it stood at 56.8% and now (following section) it's up to 86.8%.
The UK experienced five successive quarters of negative growth from the second quarter of 2008 to the second quarter of 2009 (-0.2%, -1.7%, -2.2%, -1.8% and -0.3%).
I am interested in the relationship between the size of the national debt and GDP, because (as a strict non-economist), the ballooning national debt seems on the face of it to be out of all proportion to the relatively small negative GDP numbers above. I understand the during a recession the tax take goes down and government costs like social security rise, but it's the relationship that I don't follow. Is a one of those cases where one small variable is able to 'punch above its weight', so to speak (rather like carbon dioxide in the atmosphere)?
Two other things:
Firstly, I think there's slight misconception over the use of percentages, with the implication that 'national indebtedness' runs on a 0-100 scale, when the UK national debt has been well above 100% of GDP over extended periods of time.
Secondly, 'the debt' isn't quite the same as, say, a credit card bill or an overdraft: it's a concrete amount of bonds issued over varying periods at varying rates of interest. That's how you can end up with "approximately 1/3 of the cost of servicing the debt [...] paid by the government to itself" on account of quantitative easing, which is a tactic to increase the money supply.
posted by holgate at 10:19 AM on March 22, 2016 [2 favorites]
Firstly, I think there's slight misconception over the use of percentages, with the implication that 'national indebtedness' runs on a 0-100 scale, when the UK national debt has been well above 100% of GDP over extended periods of time.
Secondly, 'the debt' isn't quite the same as, say, a credit card bill or an overdraft: it's a concrete amount of bonds issued over varying periods at varying rates of interest. That's how you can end up with "approximately 1/3 of the cost of servicing the debt [...] paid by the government to itself" on account of quantitative easing, which is a tactic to increase the money supply.
posted by holgate at 10:19 AM on March 22, 2016 [2 favorites]
The math is pretty simple: The debt is the sum of past deficits and surpluses, which equal spending less revenues. The debt to GDP ratio is that number divided by GDP.
So you're correct that the change in GDP had little to do with the increase in the debt/GDP ratio. Rather, it was the size of the deficits; see second figure here. I'm not familiar with the British budget, but the third figure here seems to show that deficits increased as spending increased, while receipts remained rather constant.
posted by Mr.Know-it-some at 10:40 AM on March 22, 2016
So you're correct that the change in GDP had little to do with the increase in the debt/GDP ratio. Rather, it was the size of the deficits; see second figure here. I'm not familiar with the British budget, but the third figure here seems to show that deficits increased as spending increased, while receipts remained rather constant.
posted by Mr.Know-it-some at 10:40 AM on March 22, 2016
i think the explanation you're looking for is that the amount of money passing through the govt is a significant fraction of gdp. income / expenditure is around 800 billion pounds per annum. the gdp is 2.7 trillion, so about 30% of the gdp "passes through" the govt.
so if the income and expenditure don't match up you get numbers that are also pretty large - numbers that, after a few years, can add up to a fair fraction of the gdp.
(disclaimer - not an economist, so please don't take as gospel truth).
posted by andrewcooke at 1:38 PM on March 22, 2016
so if the income and expenditure don't match up you get numbers that are also pretty large - numbers that, after a few years, can add up to a fair fraction of the gdp.
(disclaimer - not an economist, so please don't take as gospel truth).
posted by andrewcooke at 1:38 PM on March 22, 2016
Its really the delta in revenues vs the delta in spending.
Seconding JPD at top.
Government revenue goes down in a recession (i.e. sales, income, profit, trade taxes, etc. collections are reduced); in general costs do not go down, they increase (e.g. unemployment insurance, welfare rolls) -- and government often (rightly) tries to increase aggregate spending and consumption by increasing payments and investment where possible (hence the bonds -- borrowing).
posted by lathrop at 3:21 PM on March 22, 2016 [1 favorite]
Seconding JPD at top.
Government revenue goes down in a recession (i.e. sales, income, profit, trade taxes, etc. collections are reduced); in general costs do not go down, they increase (e.g. unemployment insurance, welfare rolls) -- and government often (rightly) tries to increase aggregate spending and consumption by increasing payments and investment where possible (hence the bonds -- borrowing).
posted by lathrop at 3:21 PM on March 22, 2016 [1 favorite]
This blog from The Economist might help: The maths behind the madness.
Or this from Paul Krugman: Debt Arithmatic
If you haven't already heard of them, you might be interested in Reinhart & Rogoff, who became very famous (for a number of reasons) studying the relationship between debt and growth. The New Yorker summarizes the whole thing here. Paul Krugman has written about them, and here are some charts and commentary from economist Brad DeLong: Accurate and Inaccurate Ways of Portraying the Debt-and-Growth Association:
In the post-WWII G-7, the high-debt low-growth correlation is overwhelmingly driven by (a) the recent experience of Italy and Japan, in which slow growth preceded high debt; (b) the high-debt UK after WWII, but UK growth did not accelerate as its debt load fell; and (c ) the low-debt defeated axis after WWII, which rapidly rebuilt and caught up to their pre-WWII levels of prosperity..
Here's another good analysis (Roosevelt Institute):
As is evident, current period debt-to-GDP is a pretty poor predictor of future GDP growth at debt-to-GDP ratios of 30 or greater—the range where one might expect to find a tipping point dynamic. But it does a great job predicting past growth.
This pattern is a telltale sign of reverse causality. Why would this happen? Why would a fall in growth increase the debt-to-GDP ratio? One reason is just algebraic. The ratio has a numerator (debt) and denominator (GDP): any fall in GDP will mechanically boost the ratio. Even if GDP growth doesn’t become negative, continuous growth in debt coupled with a GDP growth slowdown will also lead to a rise in the debt-to-GDP ratio.
Besides, there is also a less mechanical story. A recession leads to increased spending through automatic stabilizers such as unemployment insurance. And governments usually finance these using greater borrowing, as undergraduate macro-economics textbooks tell us governments should do. This is what happened in the U.S. during the past recession.
Economics power couple Betsey Stevenson and Justin Wolfers address both the Reinhart/Rogoff debate as well as the relationship between public debt and GDP growth here (with lots of good links therein).
IMF: Debt and Growth: Is There a Magic Threshold?
NY Fed: Euro Area Spending Imbalances and the Sovereign Debt Crisis, and Deficits, Public Debt Dynamics, and Tax and Spending Multipliers (pdf).
posted by triggerfinger at 5:35 PM on March 22, 2016 [1 favorite]
Or this from Paul Krugman: Debt Arithmatic
If you haven't already heard of them, you might be interested in Reinhart & Rogoff, who became very famous (for a number of reasons) studying the relationship between debt and growth. The New Yorker summarizes the whole thing here. Paul Krugman has written about them, and here are some charts and commentary from economist Brad DeLong: Accurate and Inaccurate Ways of Portraying the Debt-and-Growth Association:
In the post-WWII G-7, the high-debt low-growth correlation is overwhelmingly driven by (a) the recent experience of Italy and Japan, in which slow growth preceded high debt; (b) the high-debt UK after WWII, but UK growth did not accelerate as its debt load fell; and (c ) the low-debt defeated axis after WWII, which rapidly rebuilt and caught up to their pre-WWII levels of prosperity..
Here's another good analysis (Roosevelt Institute):
As is evident, current period debt-to-GDP is a pretty poor predictor of future GDP growth at debt-to-GDP ratios of 30 or greater—the range where one might expect to find a tipping point dynamic. But it does a great job predicting past growth.
This pattern is a telltale sign of reverse causality. Why would this happen? Why would a fall in growth increase the debt-to-GDP ratio? One reason is just algebraic. The ratio has a numerator (debt) and denominator (GDP): any fall in GDP will mechanically boost the ratio. Even if GDP growth doesn’t become negative, continuous growth in debt coupled with a GDP growth slowdown will also lead to a rise in the debt-to-GDP ratio.
Besides, there is also a less mechanical story. A recession leads to increased spending through automatic stabilizers such as unemployment insurance. And governments usually finance these using greater borrowing, as undergraduate macro-economics textbooks tell us governments should do. This is what happened in the U.S. during the past recession.
Economics power couple Betsey Stevenson and Justin Wolfers address both the Reinhart/Rogoff debate as well as the relationship between public debt and GDP growth here (with lots of good links therein).
IMF: Debt and Growth: Is There a Magic Threshold?
NY Fed: Euro Area Spending Imbalances and the Sovereign Debt Crisis, and Deficits, Public Debt Dynamics, and Tax and Spending Multipliers (pdf).
posted by triggerfinger at 5:35 PM on March 22, 2016 [1 favorite]
The debt as a percentage of GDP is a ratio: debt divided by GDP. In a recession the numerator (debt) increases and the denominator (GDP) decreases. Increasing numerator and decreasing denominator both combine to create a large increase in the ratio.
posted by JackFlash at 7:10 PM on March 23, 2016
posted by JackFlash at 7:10 PM on March 23, 2016
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Its really the delta in revenues vs the delta in spending.
posted by JPD at 10:16 AM on March 22, 2016 [4 favorites]