Guest Post: Testing Krugman's Debt Reduction Strategy (And Finding It Fails)

Tyler Durden's picture

Submitted by F.F.Wiley of Cyniconomics blog,

Nike recently published a series of ads declaring “winning takes care of everything,” in reference to Tiger Woods’ recapture of the world #1 golfer ranking. The slogan went over with certain critics like an illegal ball drop.

Many economists insist that “economic growth takes care of everything,” and the related debate is no less contentious than the Nike ad kerfuffle. Listening to some pundits, you would think there’s one group that appreciates economic growth while everyone else wants to see the economy crumble. It seems to me, though, that growth is just like winning – there’s no such thing as an anti-winning camp, nor is there an anti-growth camp.

More fairly, much of the growth debate boils down to those who think mostly about long-run sustainable growth and those who advocate damn the torpedoes, full speed ahead growth. I’ll break off one piece of this and consider:  How much of everything does growth take care of?

A typical dismissal of the dangers of excessive debt

In particular, I’ll discuss the idea that we shouldn’t worry about America’s soaring national debt because we can always grow our way out of it. Here’s Paul Krugman’s version of this claim, excerpted from his 2012 bestseller, End This Depression Now! (page 142):

We won’t ever have to pay off the debt; all we’ll have to do is pay enough of the interest on the debt so that the debt grows significantly more slowly than the economy.

One way to do this would be to pay enough interest so that the real value of the debt – its value adjusted for inflation – stays constant; this would mean that the ratio of debt to GDP would fall steadily as the economy grows.

Krugman goes on to suggest that:

  1. Using a reasonable estimate for real interest rates (2.5%), we’ll have to pay $125 billion of interest each year on the $5 trillion in additional debt that was added after the global financial crisis.  (My update: This is now almost $8 trillion.)
  2. This amount of interest is “well under 1 percent of national income,” which means that “even shock-and-awe debt numbers aren’t nearly as big a deal as often claimed.”  (My update: By Krugman’s definition of well under, the same calculation now takes the interest payment to well over 1 percent of national income.)

No way, PK, growth won’t be enough to save the day

So Krugman basically says that $5 trillion in additional debt isn’t that “big a deal.”  I’ll take a stab at showing that it is, in fact, a big deal.

First, I’ll restate the excerpt above. By suggesting we can keep the real value of debt constant and then sit back and watch growth whittle away the debt-to-GDP ratio, Krugman is saying that our primary balance (the budget balance excluding interest costs) needs to equal our accumulated debt times the real interest rate.  With our current debt of 105% of GDP and Krugman’s assumption of a 2.5% real interest rate, the primary balance needs to equal 2.6% of GDP.

Here’s the reality check, comparing a 2.6% hurdle to history:

krugman chart 1

The chart shouldn’t need much interpretation, but consider that the 1950s surplus was achieved by presidents who detested deficits and mostly ignored recommendations of the Keynesian economists of their time (as I discussed here). Consider also the post-1950s developments that make it much harder to control our finances now versus then (see here). All we could manage in the 1950s – with deficit hawks in the White House and wind at their backs – was a primary surplus of 0.9% of GDP.

In sum, reading Krugman’s book you would think that lifting the primary balance to 2.6% is easy-peezy-lemon-squeezy. But the evidence shows that just getting back to 0.9% would be Herculean, let alone raising the balance well above historic precedents.

But… but… CBO figures tell us we can spend like there’s no tomorrow

Krugman often points to CBO projections as another reason to be unconcerned about debt. Let’s look at these projections in relation to the 2.6% hurdle, zeroing in on the year 2023. I’ll use three different scenarios:

  1. The “baseline scenario” that the CBO is mandated to produce, even though it includes many “current law” assumptions widely known to be unrealistic.
  2. The CBO’s more reasonable “alternative scenario.”
  3. The alternative scenario adjusted for the effects of recessions, which are ignored in the CBO’s projections. (The CBO assumes there’s no such thing as the business cycle, as I discussed here. I’ll explain my adjustments for this nonsensical assumption in a later post.)

Here’s the chart:

krugman chart 2

I have three conclusions.

First, if you expect to close the gaps between the line and the projections at Krugman’s real interest rate of 2.5%, then I’d like some of whatever you’re smoking. The only way to make the challenge manageable is with real interest rates significantly lower than 2.5% and even negative for long stretches of time. With low real rates, the primary balance hurdle would be less than the 2.6% shown in the chart. In other words, the anemic investment yields of the last four years will be with us for a long time, as will the distortions and risks that come with them. (This conclusion shouldn’t be surprising to those familiar with past high debt episodes – see this paper, for example.) In economist-speak, these artificially low real interest rates are a form of financial repression.

Second, even with financial repression, projections show it’s incredibly optimistic to think the real value of debt can be stabilized through a full business cycle, which is a key assumption in Krugman’s scenario. More realistically, we should feel relieved if debt grows slower than the economy even if its real value is increasing.

Third, the situation gets much worse after 2023. This isn’t shown in the chart, but just wait for the CBO’s soon-to-be-published long-term projections and the recessions-really-do-exist version of those projections that I’ll post on CYNICONOMICS.

It’s also worth remembering that the 2.6% required primary balance is based on the current debt-to-GDP ratio of 105%. If policymakers were to heed Krugman’s frequent recommendations to increase deficit spending, the debt-to-GDP ratio would continue to grow and the primary balance hurdle would grow along with it.  The hurdle would rise even further above both historic precedents and future projections. This makes it even more important to see through irresponsible claims such as those in End This Depression Now! Both history and common sense tell us that “shock-and-awe debt numbers” are a big deal; an inability to control those numbers can be disastrous for long-run growth (as I discussed here); and economic growth doesn’t “take care of everything.”

Recommended link (and technical note)

Just yesterday, James Hamilton published an excellent article that also includes a history of our primary balances. He calculates the surplus required to stabilize the net debt-to-GDP ratio at different combinations of interest rates and GDP growth. This is different than Krugman’s scenario of falling debt-to-GDP ratios for gross debt. Now, Krugman’s reported debt for the end of 2010 is actually in between the net and gross figures published currently by the IMF (the source used in his accompanying chart), but other figures cited in the same section of his book are for gross debt and one would assume he’s not comparing apples to oranges.  I discussed the difference between net and gross debt here.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Zer0head's picture

matrimony is a great thing, like debt reduction you just grab it by the throat ( in a playful manner )


from the man who brought you just about every brand on the planet via Saatchi & Saatchi (currently‎ )

this photo journal featuring brother Charles Saatchi and his lovely wife Nigella Lawson in a playful tiff (gotta luv those (M)ad men)

TruthInSunshine's picture

A true gem found by ZH from the not-so-way-back-machine that is yet another piece of damning evidence (in a literal mountain high stockpile of such pieces of evidence) establishing Krugman's irrefutable status as one of the world's biggest LIAR, HYPOCRITE & DOUCHEBAG:

A Fiscal Train Wreck

With war looming, it's time to be prepared. So last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I'm terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits.

From a fiscal point of view the impending war is a lose-lose proposition. If it goes badly, the resulting mess will be a disaster for the budget. If it goes well, administration officials have made it clear that they will use any bump in the polls to ram through more big tax cuts, which will also be a disaster for the budget. Either way, the tide of red ink will keep on rising.


Last week the Congressional Budget Office marked down its estimates yet again. Just two years ago, you may remember, the C.B.O. was projecting a 10-year surplus of $5.6 trillion. Now it projects a 10-year deficit of $1.8 trillion.


And that's way too optimistic. The Congressional Budget Office operates under ground rules that force it to wear rose-colored lenses. If you take into account -- as the C.B.O. cannot -- the effects of likely changes in the alternative minimum tax, include realistic estimates of future spending and allow for the cost of war and reconstruction, it's clear that the 10-year deficit will be at least $3 trillion.


So what? Two years ago the administration promised to run large surpluses. A year ago it said the deficit was only temporary. Now it says deficits don't matter. But we're looking at a fiscal crisis that will drive interest rates sky-high.

A leading economist recently summed up one reason why: ''When the government reduces saving by running a budget deficit, the interest rate rises.'' Yes, that's from a textbook by the chief administration economist, Gregory Mankiw.


But what's really scary -- what makes a fixed-rate mortgage seem like such a good idea -- is the looming threat to the federal government's solvency.

That may sound alarmist: right now the deficit, while huge in absolute terms, is only 2 -- make that 3, O.K., maybe 4 -- percent of G.D.P. But that misses the point. ''Think of the federal government as a gigantic insurance company (with a sideline business in national defense and homeland security), which does its accounting on a cash basis, only counting premiums and payouts as they go in and out the door. An insurance company with cash accounting . . . is an accident waiting to happen.'' So says the Treasury under secretary Peter Fisher; his point is that because of the future liabilities of Social Security and Medicare, the true budget picture is much worse than the conventional deficit numbers suggest.

Of course, Mr. Fisher isn't allowed to draw the obvious implication: that his boss's push for big permanent tax cuts is completely crazy. But the conclusion is inescapable. Without the Bush tax cuts, it would have been difficult to cope with the fiscal implications of an aging population. With those tax cuts, the task is simply impossible. The accident -- the fiscal train wreck -- is already under way.


How will the train wreck play itself out? Maybe a future administration will use butterfly ballots to disenfranchise retirees, making it possible to slash Social Security and Medicare. Or maybe a repentant Rush Limbaugh will lead the drive to raise taxes on the rich. But my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt.

And as that temptation becomes obvious, interest rates will soar. It won't happen right away. With the economy stalling and the stock market plunging, short-term rates are probably headed down, not up, in the next few months, and mortgage rates may not have hit bottom yet. But unless we slide into Japanese-style deflation, there are much higher interest rates in our future.


I think that the main thing keeping long-term interest rates low right now is cognitive dissonance. Even though the business community is starting to get scared -- the ultra-establishment Committee for Economic Development now warns that ''a fiscal crisis threatens our future standard of living'' -- investors still can't believe that the leaders of the United States are acting like the rulers of a banana republic. But I've done the math, and reached my own conclusions -- and I've locked in my rate.


- Paul Krugman, Ph.D., Nobel Laureate in Economics, Professor of Economics at Princeton, Proponent of 77 trillion USD "When Mars Attacks" Stimulus Pan, Endorser-In-Chief of Greenspan's Blowing of Housing Bubble v1.0, and all-around Douchebag

March 11, 2003


not a twin's picture

Nah, the quicker way to get money into the economy is with divorce - wedding planners don't charge nearly as much as divorce lawyers.

otto skorzeny's picture

A Tale of Two Cities Part Deux coming soon.

Dr. Engali's picture

Not only are the muppets getting screwed by Goldman trading against them, now Sesame Street has a dedicated muppet whose parents are in jail:

What's it take for a muppet to catch a break?

knukles's picture

Datz razzizt.  He be gots red skin like Humerican Injuns.  White man say we criminals like Tonto?

whotookmyalias's picture

Good grief.  I hope that big bird smacks him and says "your parents broke the law and must be held accountable for their own actions".

knukles's picture

And since they're both in prison, here's an EBT card and section 8 vouchers, Obamacare card and a new iphone.
Fuck yeah!

Ropingdown's picture

You left out Medicaid and some SSI for the kid.

Yen Cross's picture

    Let's look at Dr. Krugmans pendulem of weath expansion.

  Based on Krugmans growth model, his (QE) gdp should have gross model top of 3.5%.  We're pushing 1.8%(laughably)


knukles's picture

Soon to include a compleate and accurate accounting of intangibles, too!
Whoopie shits!

(looking for something to throw that won't break dent bend spindle fold or mutilate)

jon dough's picture

Throw a party and get shitfaced...

That's what I'm doing.

jon dough's picture

The Glenlivet, steak, salad.

One of the very few ways I live a little large. Gettin' harder, tho...

Thx YC

insidious's picture

"So Krugman basically says that $5 trillion in additional debt isn’t that “big a deal.”  I’ll take a stab at showing that it is, in fact, a big deal."


What the hell? Only when attempting to argue with someone who lives in a world of economic theories and mathematical formulas would someone need to show that adding $5 trillion dollars of debt, in today's USA, is in fact a big deal.

IridiumRebel's picture

Some people say "FAIL". I propose we supplant that with a ZH only term. KRUG.


" Japan is easing again"
ZH poster: "KRUG".

jon dough's picture

Krugman + kluge = ...


"An unholy, fucked up, stump broke, grabasstic piece of amphibious shit..."

Just trying to get the nuance right...

bonin006's picture

Stop insulting the salamanders.

Evil Bugeyes's picture

But in 2003, Krugman was terrified that deficits would send interest rates sky-high:

Tulpa's picture

"It seems to me, though, that growth is just like winning – there’s no such thing as an anti-winning camp, nor is there an anti-growth camp."

Afraid I must disagree on that.  Despots do pretty damn well in times of economic stagnation, be it in Eurasian socialist infernos or Arabian petrolarchies.  You think the House of Saud and all those emirs want to deal with a middle class demanding freedom and stuff?  Not on your life.

Yen Cross's picture

    Any sane economist knows that growth is 'finite'. Forcing growth in new areas does open doors.

    Humans have [faught/fought] to stay out of "filth and plague" for centuries. Hundreds of millions of us have been lost.



evernewecon's picture



Anti-Austerity Result Of

Exhaustive Kimball And

Wang Study 


Krugman "Admires" Rogoff 


Krugman Says

Garbage In Garbage Out



See The 2.2 Not -.1% With

Debt To GDP Over 90%



The Result Of The Totality Of

The R/R Study Is Close 


To The

Result Of Its Critics', However. 


Shiller earlier: 


Jurow On Shiller 


But No One Mentions The Cost

Of Shafting That Comes From

Monopoly, Risk Filtering,

Gatekeeping And Pay To Play.

And Then The Privatizers

Have A Free Hand.   

Incarcerating instead of educating

is but one of a potentially infinite

number of ways by which people in the cat

seat take advantage of the vulnerable,

including when the former created the



(was just the beginning)

Loss Sharing, Free Reserves

For Years, Liquidity Trap, The

"Static," "Fragile" Monopolistic

Effects (benchmarking to 0, the banks

themselves afraid of rising rates  )

Not Just In Banking

But Other Major Sectors, With


Concomitant And Additive

To That, Sustaining Wars, Etc.

This Understates The Case.

Who Knows How Much Left

The Country.  The Fed/

Congress Are Desparately

Reflating The Last Bubble

That Created The Mess.

TBTF Still Prevails.  

Rinse And Repeat.

Clearly not all control freaks

are the same, but they seem to

form a coalition around money

with little trouble.

And for those who happen to be

sell-outs the goal of winning has to be the

primary rationalization.  

I'm not here to criticize.  In "Big Chill,"

Michael Gold says rationalization is more

important than sex--have you ever gone a

day without a rationalization?

Many people sell

out for want of another way to make a living.

People really only get tee'd off where those

engaging in it do so at others' expense while

thinking they're doing something special.

If it were me I'd say "my field--I'd do things

differently though."

Me earlier at Zerohedge as to the point of

(economic) absolutes, obviously relevant

to this article (I don't spam.)

Yen Cross's picture

 Those dastardly Rats> Scaredd

ejmoosa's picture

The amazing assumption that leaves me scratching my head  is that there are so many people and institutions who have loaned trillions of dollars to the Federal Government, and the belief seems to be they will never want it back.  


As soon as they see a better option, I think they will be demanding it back rather quickly.

The Invisible Foot's picture

If there were no debts in our money system there wouldn't be any money." -Marriner Eccles- Governor of the Federal Reserve September 30th, 1941

Totentänzerlied's picture

"nor is there an anti-growth camp."

You rang?

andrewp111's picture

The extra debt isn't a big deal if Benny buys the debt as 30 y bonds in POMO operations and the Gubbermint pays interest back to itself for 30 years. By then those dollars are inflated down to half their value even at current inflation rates. Don't be surprised if all the extra debt (and more) ends up on the Fed's balance sheet. But this too has a big cost as it deprives the private sector of all that interest income.

GreatUncle's picture

Adding 5 trillion is no big deal. Depends and 2 scenarios.

If your current debt = 0 then 5 trillion is no big deal.

If your debt is about 50 trillion and at 52 trillion you reach the point that Japan is fast approaching 

---------->>>>>>>>> the in your face absolutely posative default level.


On a long enough timeline ZH do all Keynes economies go bust? The words are yours I just added the ending.


SilverMoneyBags's picture

Krugman doesn't understand what the word "growth" means. He thinks its a nominal value in a model and relates it back to whether or not the State can function and remain solvevent. He doesn't understand that growth really means that its the PEOPLE not the State that becomes more prosperous. 

Debugas's picture

it is kind of obvious that poeple in debts are in debts for a reason - their income is lower than their spending - so it is unlikely that by throwing money into economy it will help to repay the debts. Most of the money will end up in the hands of those who never had debts and had been accumulating wealth


Why is it so difficult for economists to understand that money in the system does not flow in a closed circle but rather from the bottom to the top of the pyramid (from poor to wealthy) and stays at the top

css1971's picture

FFS! You can't "grow" your way out of debt. The "growth" everyone talks about is literally growth in total (not just governmental) debt.

All you ever do with the current monetary system is move the proportion of debt between consumers, corporations and government. No the debt is NOT 16.8 Trillion. The debt is 50 Trillion.

hooligan2009's picture

sigh...all this crap about "primary surplus" making things fine because in this way there is no "structural deficit" is becoming quite tedious.

Italy on this basis should be has a "primary surplus"..but guess what isn't, because the interest burden on its massive debt makes the interest burden part of the structural problem.

italy's interest burden is 5-8% of GDP because its government debt to GDP is 130% (up form 70% ten years ago) and its ten year bond rate (or the average cost of accumulating debt over the last fifty years) is 4-6%. Becuase of Italy's government finances, its economy has gone underground so its black economy pays no taxes and takes up to 30% of economic activity, not captured by official GDP numbers. in other words, the economy has a lot of "economic criminals" who aren't at all like robin hood and his bunch of merry men in tights and more like berlusconi and his bunga bunga women in stockings and heels.

the interest burden in italy where govenrment spending is what, 50% of GDP? means that interest takes a larger and larger share of italy's case it takes 5-8% of gdp equates to 10-16% of the total tax take.

each year that goes by with a fiscal deficit (with a primary surplus and a larger structural deficit) increases the problem for italy.

i challenge anyone to say that spending one eighth of taxes on interest can do anything other than reduce gdp growth.

it is no accident that the europeans decided over 20 years ago in 1992 that government debt to gdp should not exceed 60% or that long term interest rates must not be more than 2% above the three lowest inflation countries.

europe is failing because of government and central bank stimulus polices, bad lendiing practices and corruption a la bunga bunga in the periphery. it is however, doing something about it. Japan, the US and the UK are not, labelling living within fiscal means as "unwarranted austerity" and "shortsightedness". the opposite is beyond fiscal means causes poverty, crime and corruption.



topshelfstuff's picture


Not going to detail it again, my best guess, most common sense scenario calls for a ReValuation of the USD, kinda like a Reverse Split. I see it at 100 NEW USD's for each $1 Current. With at least 2 Line Items included:


The keeping of both Mortgage and Student Loans FIXED at the Current USD level, yet Payable with the NEW USD's. These two "problems" settled and fair, since All Mortgage & Student Loan Holders get to use it.


The big Plus is in regards to our Foreign Debt, which will get paid Dollar for Dollar, just with the NEW USD's, equal to 1% of the Current Value.


Until about a year or so ago I didn't realize it, but since then I can see this being done with the EURO at the same time. The YEN Currency is already like this, a country where being a "Millionaire" is common, so it will be here, simply making Billionaire carry the same meaning as Millionaire does now in the US. Will need about 10 days or so to call in All Cash to Exchange for the New, all Banking and Investment accounts will easily be reset.

Carp Flounderson's picture

Your math doesn't make sense, but I suppose you probably know that.  Doing the math in a way which actually makes sense doesn't fit your narrative, does it ;)