Thursday, August 11, 2011

Why The US Does Not Have An Unsustainable Debt to GDP Ratio

link here to article

Jamie Galbraith explains why the US does not have a long term debt to GDP ratio problem. He argues that the flaw in the CBO long term budget forecasts is the assumption that the US must offer investors a real interest rate greater than the GDP growth rate. That assumption guarantees unsustainability. It would require that the US run a budget surplus in order to achieve a sustainable path. If it ran a budget surplus, the GDP growth rate would fall below the real interest rate and become unsustainable.

Galbraith provides a simple model that defines sustainability and which shows that the US can have a real interest rate on its debt, below the growth rate of GDP. That would require that the US runs a budget deficit and that the sustainable deficit gets larger as the debt burden grows. That is what the US has done by running budget deficits since the 1930's. That also explains why Japan can get away with a 200% Debt to GDP ratio. It borrows money at negative interest real interest rates.

Galbraith concludes by arguing that US policy should be to maintain low interest rates via Fed policy and to let the economy recover without worrying about the current debt to GDP ratio. We are on a sustainable path as long as the real interest rate is below the growth rate of GDP.

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