Debt Deal Delusions: Debt to Gross Domestic Product Ratio


The compromise "is a positive step toward reducing the future path of the deficit and the debt levels,” Steven Hess, senior credit officer at Moody’s in New York, said in a telephone interview yesterday. “We do think more needs to be done to ensure a reduction in the debt to GDP ratio, for example, going forward." Bloomberg, Aug 2 (Image: Okko Pyykko)

How many times have you read or heard about the magic numbers concerning the ratio of national debt to gross domestic product (GDP)? This was trotted out by both sides of the debt ceiling debate as a fact: if the debt-to-GDP ratio exceeds 90%, the results will be dire. Therefore, our current situation calls for a crisis reaction and extreme measures to get below the magic number.

The problems with this analysis and the underlying research were never examined. This crisis worked so well at diverting public attention away from the real budget problems, we can assume there will be more debt ceiling crises in the future. It is worth understanding the problems with this ratio and the reasons to view conclusions and subsequent actions based on it as specious

Robert J. Shiller debunked this assumption in a short article written during the debate. He is a professor of economics at Yale and co-author of the respected Case-Shiller Housing Price Index.

Shiller makes some important points debunking the value of the ratio.

1. The ratio confuses cause and effect, the predictor and outcome variables. That's the type of error that gets your thesis proposal tossed out at your initial presentation. It's terribly humiliating, I'm told, and something graduate students in all disciplines go to great lengths to avoid. Here's what Shiller says;

"There is also the issue of reverse causality. Debt-to-GDP ratios tend to increase for countries that are in economic trouble. If this is part of the reason that higher debt-to-GDP ratios correspond to lower economic growth, there is less reason to think that countries should avoid a higher ratio, as Keynesian theory implies that fiscal austerity would undermine, rather than boost, economic performance." Robert Shiller, Delusions and Debt July 21

The debt problem is defined as the measurement of the problem -- a 90% or greater debt-to-GDP ratio. This is like manipulating a thermometer to show a lower body temperature and expecting that the lower measurement will alleviate the physical symptoms of a severe fever. It is backwards reasoning, to say the least.

The outcome of this reverse causality, leading to austerity, is already projected. The final version of the bill just passed could cost up to 1.8 million jobs if only the following job killing cuts re put in place. From the Economic Policy Institute:


2. The Debt-to-GDP ratio is based on an arbitrary unit of time and, as such, makes no real sense. Shiller:

"Could it be that people think that a country becomes insolvent when its debt exceeds 100% of GDP?

"That would clearly be nonsense. After all, debt (which is measured in currency units) and GDP (which is measured in currency units per unit of time) yields a ratio in units of pure time. There is nothing special about using a year as that unit. A year is the time that it takes for the earth to orbit the sun, which, except for seasonal industries like agriculture, has no particular economic significance. Robert Shiller, Delusions and Debt July 21

Shiller points out that, in the case of Greece, if you "decadized" the debt over 40 years, the Debt-to-GDP ratio would be 15%, a figure the Greeks could be expected to pay. The conclusion that might be drawn from the analysis is that the crisis in Greece and the purported crisis in the United States are manufactured for the purposes of creating a crisis.

3. Shiller debunks the underlying analysis used to formulate the Debt-to-GDP ratio. The work announcing the 90% danger zone was by Reinhart and Rogoff, Growth in a Time of Debt, published at the end of 2009. This is supposedly the empirical basis for the 90% warning signal for dangers from Debt-to-GDP. Shiller points out:

" … Reinhart and Rogoff picked the 90% figure almost arbitrarily. They chose, without explanation, to divide debt-to-GDP ratios into the following categories: under 30%, 30-60%, 60-90%, and over 90%. And it turns out that growth rates decline in all of these categories as the debt-to-GDP ratio increases, only somewhat more in the last category." Robert Shiller, Delusions and Debt July 21

So we've had a debt crisis based, in large part, on a study that reversed causality, picked an arbitrary unit of time (one year) for the ratio used, and created arbitrary categories, including the magic 90% and above danger zone, where there were the differences in declining growth were not that remarkable. The reversed cause and effect mistake is enough to throw the entire theory out.

But if Professor Shiller's erudite analysis doesn't satisfy you, here's one more reason to reject the debt ratio argument. It excludes manipulation and bad judgment.

The study by Reinhart and Rogoff notes the following countries as having the worst Debt-to-GDP ratios. Shiller pointed out that the measure isn't the cause of the crisis rather, the crisis causes the ratio. In practical terms, fixing the ratio is not guaranteed to fix the underlying causes of the economic crisis.


A variation of the causality critique is obvious. Iceland, Ireland, and Spain were subject to various manipulations by internal and international finance. The governments of the UK and US were subject to and enablers of the same manipulations. The variable that's missing is outside manipulation and government complicity in that manipulation. Absent the machinations of Wall Street and the City of London, would any of these countries have the same Debt-to-GDP ratios?

Those brave enough to watch on C-Span have endured the ranting and fulminations of a bunch of male hysterics. So sure of themselves, so expert at everything, so willing to take the country down as low as it can go economically -- all for a set of cherished assumptions. This is one of them. We should thank Robert J. Shiller for calling it what is -- a delusion.


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There you go again

There you go again ... critical thinking, questioning authority ... rather than meek acceptance of the latest okeydoke from approved pundits!

Oh my.

Welcome! And muchos gracias to Prof. Shiller!

What a mind and what clear analysis. It's a short essay. He thoroughly debunks the major scare tactic of the budget obsessed male hysterics who embarrassed everybody over the past few weeks. I especially liked the cause-effect point. My minor point added on the Reihart-Rogoff analysis is like picking low hanging fruit. One would think with all the concern among "new age" economists about the influence of regulations, the various regulatory regimes over the 200 years measured would have been a variable. But hey, Shiller took care of the delusions handily.

Cheers to you!

it is 99% for Q2 2011

Q2 GDP about $15 trillion, debt, $14 trillion. I think the common problem with debt to GDP is the IMF and OECD. They all use this metric.

Debt cutting though will reduce the economy, no doubt about it. The problem I have generally with deficit spending as stimulus is Keynes made it pretty clear it should be targeted.

The multipliers only work when the funds are kept in the domestic economy plus go directly to the people, the workers, the "consumer".

We never got a stimulus with a real direct jobs problem that keep the funds in the United States and made targeted investments to boot. Say critical infrastructure rebuilding as an example.

Or a state sponsored VC fund where it was required all workers must be U.S. citizens and all production must stay inside the United States, as another.

But bottom line the U.S. economy is smaller than Q4 2007. Plus we have massive people unemployed, on social services to survive and so on, so I like your piece acting like this ratio is static or some real common sense policy and bills wouldn't help the situation out.

Thats...where the snow is thick now. We have all of the politicians touting corporate lobbyist agendas as "jobs" programs and it's positively disgusting.

Trade deals which will lost thousands of jobs, patent law that's all about multinational corporations and nothing about the U.S. innovator...

and these insane GOP who try to claim some tax loophole which makes it even more profitable to offshore outsource jobs is some sort of "jobs program".

No wonder the globe laughs at us now.

A treatise in a reply;)

You hit the high points. I really like the VC fund with domestic only labor and location. There are so many talented people out there ready to rock and there's not much money. Cut our beleaguered Uncle Sam in on a bit of those deals too ongoing and protect ownership of the product for the inventor.

Compare the two debates on fundamental issues - Wisconsin versus the US Congress. There's no contest. God bless the people of Wisconsin and best wishes to a house cleaning recall process.

FAA as a prime example

The fact Congress went on a 5 week recess while leaving the FAA hanging and losing billions in taxes, never mind the 100k people left handing, without jobs is a prime example, not just of this insane asylum of corruption and inability to do anything common sense, plus abandoning their posts when they needed to act...

But to me implies something wrong structurally with this government. I hate to say it but the government is a huge institution and it should be run more like a business. I'm obviously not for privatization in the least, but letting Congress do crap like this, administration is a huge problem.

They were never supposed to touch the social security trust fund, as a case in point. If they were pension fund managers they would not only be fired by probably prosecuted for putting pensions at risk, both civil and criminal court.

How to you rely on the government when beyond incompetent management, almost always by "elected" officials, they play their political games with service agencies like this?

Structurally this needs to be stopped and beyond having a "redo" and enacting a parliamentary system with a unicameral Congress or whatever, something has to give with the crazies running the nation. (into the ground).

Retrograde Mutants Never Miss a Chance to Bust Unions

Secretary Lahood fought for unionization through FAA board membership nominations early this year. That means the mutants have to kill the FAA tax even if safety inspection is cut, construction stops, and planes fall from the sky.


Delta, one of the few large airlines that is largely nonunion, has beaten back recent efforts by the International Association of Machinists and Aerospace Workers to organize 13,000 Delta baggage handlers and other fleet service workers and 15,000 ticket agents and other passenger service workers. In November, the Association of Flight Attendants failed in its effort to be recognized as the union representing 20,000 flight attendants at Delta.

That effort failed even though the National Mediation Board, which oversees airline and railroad labor matters, a few months earlier changed a 76-year-old rule, making it easier for unions to win a representation election. Under the old rule, workers who did not vote were counted as “no” votes; under the new rule, only those casting ballots count.

Industry officials immediately condemned that change and said the Obama administration, which appointed two of the mediation board’s three members, was doing a huge favor for organized labor. Republicans in Congress have picked up that claim.

Burton Leed


Shiller discussed "dacadizing" 40 quarterly GDP numbers, which would put Greece's debt burden at 15% after one decade...

"And if they habitually decadalized GDP, multiplying the quarterly GDP numbers by 40 instead of four, Greece’s debt burden would be 15%."

...Not four decades.
Shiller points out that, in the case of Greece, if you "decadized" the debt over 40 years, the Debt-to-GDP ratio would be 15%, a figure the Greeks could be expected to pay.
-Debt Deal Delusions: Debt to Gross Domestic Product Ratio