How Long Until The Next Debt Ceiling Debate?

Everyone understands that the federal government debt ceiling will eventually be increased, but much of the policy discussion in the past week has focused on the harm from a default that could be triggered by a delayed increase in the ceiling.  Few journalists are asking by how much the debt ceiling will be increased and when Congress is likely to confront this problem again.  The debt ceiling was increased 50 times between June 1965 and 2002 and ten times in the past decade.  The following chart plots the number of years between each increase in the debt limit.

Debt1

Debt ceiling increases have become larger in magnitude and less frequent.  From 1965 to 2002 the average debt ceiling increase was effective for 277 days, on average.  Over the past decade the average debt ceiling increase was effective for 380 days, an increase of 37% over the prior four decades.  Overall, 78% of increases in the debt ceiling were effective for one year or less, 50% required a subsequent increase in less than 8 months, and 25% required another increase within four months.  Only four increases in the debt ceiling were effective for at least two years.  If this Congress were to raise the debt limit comparably to the median previous Congress, it will need to address the question of another debt increase on about June 10 of next year.

Debt ceiling increases in the past decade have been more than twice as large, relative to GDP, as they were between 1965 and 2003.  The following chart plots the magnitude of each increase in the debt ceiling from 1965 to the present.

Debt2From 1965 to 2002 the average debt ceiling increase was equivalent to about 3.46% of GDP.  The past ten increases raised the debt ceiling by an average of 7.09% of GDP.  The distribution of previous debt increases is skewed; about half raised the debt limit by less than 2% of GDP and one-quarter by less than 1.2% of GDP.  If this Congress were to increase the debt limit comparably to the median previous Congress, in terms of the share of GDP, expect a $325 billion increase or enough to cover the deficit for about six months.

Many taxpayers and voters would like to avoid another government shutdown knowing that a shutdown means that monuments will be barricaded, citizens will be inconvenienced, and furloughed federal workers will receive back pay for days that they didn’t work.  While default on federal debt obligations is not an option, it may make sense for conservatives who prefer smaller government to link a larger than typical increase in the debt ceiling to tax and entitlement reform.  Half of debt ceiling increases since 1965 were effective for less than 8 months and many only covered the federal deficit for about four months.  A larger than typical increase in the ceiling would mean that another government shutdown wouldn’t occur for at least a few years.  Taxpayers should support such a large increase in the debt ceiling if it is accompanied by entitlement reform and tax reform that promotes economic growth.  If future tax and spending reform is not linked to the increase in the debt limit, expect another debate over debt, spending and taxes in 4 to 8 months when the Congress will need to raise the debt limit once again.

Note: The data on federal debt limit increases I used was found here and here.

Public Debt, Growth and Exaggeration

A Working Paper released earlier this week by Herndon, Ash and Pollin (HAP) of the University of Massachusetts identified some data processing errors in the widely cited 2010 paper “Growth in a Time of Debt”, by Reinhart and Rogoff (RR).  These errors cast doubt on some of RR’s conclusions.  Unfortunately, in the Working Paper and an April 17th opinion piece in the Financial Times by Robert Pollin and Michael Ash, claims about the empirical relationship between public debt and growth are exaggerated.  HAP’s conclusion that countries with public debt ratios in excess of 90% grow no more slowly than countries with public debt ratios of 30% to 90% is incorrect and based on an inappropriate statistical test.

RR’s thesis is that there is a threshold for the debt-to-GDP ratio beyond which a country’s growth rate drops markedly. Although their previous work suggested that debt thresholds are “importantly country-specific”, their 2010 paper suggested that for many countries the debt threshold was about 90% of GDP.  A conclusion from the simple empirics in their 2010 paper is that a country’s growth rate is likely to drop once its public debt exceeded 90% of its GDP, but debt ratios below 90% had no significant impact on growth.

The following Table is based on the corrected RR data used by HAP in their Table 4.  It shows an inverse relationship between public debt to GDP ratios and GDP growth.  Growth rates are significantly slower for countries with debt ratios between 30% and 90% relative to countries with debt ratios less than 30%.  There is no significant difference, however, in the growth rates of countries with debt ratios in the 30% to 60% and 60% to 90% ranges. 

Debt /GDP

Avg. Growth

Avg. Growth Relative to <30% Debt/GDP

(t-statistic)

Observations

< 30%

4.17%

 

426

30%-90%

3.12%

-1.05%   (5.74)

639

30%-60%

3.09%

-1.08%   (5.43)

439

60%-90%

3.19%

-0.99%   (3.93)

200

>90%

2.17%

-2.01%   (6.41)

110

90%-120%

2.41%

-1.77%   (4.93)

79

>120%

1.56%

-2.61%   (4.80)

31

In the Financial Times Pollin and Ash state: “Using the Reinhart/Rogoff data, we found that the average GDP growth rate for countries carrying public debt levels greater than 90 percent of GDP was either comparable to or higher than those for countries whose debt ratios ranged between 30 percent and 90 percent.”

This assertion is based, in part, on the statistical test described in the notes to their Table 4.  HAP tested the joint hypothesis that the 3.19% growth rate in countries with a debt ratio of 60% to 90% and the 2.41% growth rate in countries with debt ratios of 90% to 120% are both equal to the 3.09% growth rate for countries with debt ratios of 30% to 60%.  HAP fail to reject this joint hypothesis, with a p-value of .11. 

HAP conducted a statistical test that is inappropriate for evaluating the RR claim of a debt ratio threshold at 90%.  RR do not claim that debt ratios of 60% to 90% are associated with lower growth rates than debt ratios of 30% to 60%.  It is unclear why HAP conducted a joint test and compared growth rates among countries with moderate debt.  HAP failed to find significant differences in growth rates among countries with public debt ratios from 30% to 120% because they conducted a joint statistical test that included a hypothesis unrelated to the 90% threshold.

Using the same data, I conducted alternative statistical tests of the Reinhart-Rogoff claim that debt ratios in excess of  90% reduce growth compared to debt ratios in the 30% to 90% range:

  • The 2.41% growth rate in countries with debt ratios of 90% to 120% is significantly lower (p-value=.041) than the 3.12% growth rate in countries with debt ratios of 30% to 90%.
  • The 2.17% growth rate in countries with debt ratios of 90% or more is significantly lower (p-value=.002) than the 3.12% growth rate in countries with debt ratios of 30% to 90%.

In the countries and time periods used in the HAP study, average growth rates were significantly lower when debt ratios were above 90%.   This empirical finding merely reflects an association between growth rates and debt/GDP.  The threshold effect for debt ratios that RR describe is weakened by the adjustments and corrections noted by HAP.  However, it is inaccurate to say that average growth rates in countries with debt ratios in excess of 90% are comparable or higher than growth rates in countries with 30% to 90% debt ratios.

The data used by RR, as corrected by HAP, show that growth is significantly slower in countries with debt ratios in excess of 90% compared to countries with debt ratios of 30% to 90%.  Growth rate differences around a 90% debt threshold are less dramatic after making the corrections suggested by HAP.  Although simple comparisons of average debt ratios and growth rates across countries and over time are illustrative, at best, the HAP critique has not changed the evidence; high public debt is associated with slower growth.

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