James Hamilton on Debt

I want to draw your attention to an interesting if wonkish post by James Hamilton summarizing his findings on the economic impact of external debt and Paul Krugman’s criticism of Dr. Hamilton’s recent WSJ op-ed. Here’s his retort:

It is true that you won’t find statistical confirmation of the nonlinearities reported in equation (3) if you confine yourself to recent experience in the major non-eurozone advanced economies. There’s a simple reason for that– these countries have not yet reached the tipping point in the dynamics of fiscal debt loads.

Are Krugman and O’Brien claiming that they never could? Do they maintain that U.S. debt could become an arbitrarily large multiple of GDP with no consequences for yields? If they acknowledge that there is a level of debt at which these effects would start to matter for the United States, what is their estimate of that level, and how did they arrive at it?

In our paper we offer our answer to these questions. We conclude that a country’s debt limit depends on its borrowing rate, its economic growth rate, and the fraction of GDP that the public is willing to commit to maintaining a permanent primary surplus– that is, government revenues minus spending on all items other than interest expense. If Krugman, O’Brien, or anybody else thinks they have some other answer, let them articulate it clearly and cleanly.

Whether a country is able to borrow in its own currency is completely irrelevant for the above calculation. Yes, it means the country likely won’t technically default on the debt, and could always create new money to pay off the creditors. But as Reis (2013) and Leeper (2013) have recently explained, printing money does not generate any magical resources with which to resolve a real fiscal shortfall. The central bank could create some more inflation, but anticipated inflation does nothing to alter the above determination of the limits on government debt.

20 comments… add one
  • steve Link

    I think Hamilton has the better of it, though I am not sure he knows when we hit that tipping point either. He kind of skips over Japan and we know Britain sustained higher levels of debt than is currently thought to be good. I would rather not find that tipping point.

    Steve

  • Icepick Link

    I would rather not find that tipping point.

    Which is why you vote exclusively for the party that institutionalized trillion dollar deficits. @@

    Ignore what they say, watch what they do.

  • But as Reis (2013) and Leeper (2013) have recently explained, printing money does not generate any magical resources with which to resolve a real fiscal shortfall.

    Jesus…there had to be 2 peer reviewed articles to explain this? Holy Mother of God…..

    This by the way was one of my beefs with Ben Wolf. I tried to point out that a country can’t keep printing money indefinitely that there has to be an upper bound and it is likely linked to actual resources the economy can produce/has produced.

  • Unfortunately, that doesn’t have much effect. He’ll just argue semantics with you, e.g. the Fed doesn’t actually print money, the Treasury doesn’t actually have debts, etc.

  • I think Hamilton has the better of it, though I am not sure he knows when we hit that tipping point either.

    I think Hamilton would agree, at least in the sense that his model is always going to be imperfect. But that his model indicates that there is a tipping point suggests that fiscal policy be prudent…that is a good thing. Krugman, et. al. on the other hand seem to scoff at the very notion of a tipping point.

    It is also amusing that Krugman points to Japan as to why Hamilton, et. al. is nonsense, but doesn’t explain why Japan’s economy isn’t going full speed ahead given that they have racked up massive amounts of debt themselves…kind of like he advocates for the U.S.

  • Ben Wolf Link

    Yes, Dave. Being correct is semantics, what really matters is hanging on to opinions that are refuted by observation again and again and again.

    But don’t let that stop you. We’ve already passed the authors’ suggested tipping point (try reading the paper), but in five years you can put up another silly post on avoiding the inevitable fiscal armageddon which will happen any second now.

  • …try reading the paper….

    And what tipping point is that?

  • Ben, the Treasury sells bonds. Bonds are, by definition, debt instruments. Consequently, the Treasury has debts. When people say “print money”, it doesn’t matter whether there’s actual printing going on or credit is being issued. It means the same thing.

    The empirical evidence supports the idea that Chartalism is ruinous. There’s just no way to fine-tune the process enough to avoid hyperinflation. What governments have successfully pursued Chartalist policies? The only government I know of that was documentably highly influenced by Chartalism is Weimar Germany.

  • TastyBits Link

    There is an amount of inertia that needs to be overcome first. This is usually not taken into account. A bigger system will take a lot longer to reach failure than is usually anticipated. A dynamic system is also able to adjust to changes. The US economy is like a aircraft carrier. If the engines stop, t will take a long time to stop. It can still maneuver, and it can be fixed before it runs into something.

    The Japanese experience with long term debt creation can provide some guidance for the US, but the size difference will dampen some of the effects. When credit is added to the money supply, the effect of additional money into the system is dampened, also.

    I would expect the US economy will drag along the bottom for longer than anyone anticipates. The US debt and Fed printing will extend this period, but it will be difficult to distinguish the added effects. This difficulty will be used to support the calls for more US debt and Fed printing.

    In the end, this is a political debate, and the economics matter little. Everybody wants to spend, but the other guy’s spending is the problem.

  • Still waiting for a response…probably wont get one.

  • Ben Wolf Link

    I’m sorry, which “chartalist” was making policy in Weimar Germany? Why have you once again ignored the actual historical record there? What you just wrote clearly indicates you have a superficial knowledge of the circumstances there.

    I’ve written this before here (apparently it was ignored) and I’ll do it again one last time:

    Germany lost a war. Losing wars have serious psychological effects, including legitimacy crises.

    Germany had massive debts imposed on it in currencies it did not control (that alone means “Chartalist” policies were impossible given one of the major no-no’s is debt in currencies you do not control).

    France and Belgium confiscated the Ruhr in 1922, robbing Germany of a massive portion of its productive capacity (Steve Verdon will within seconds insist I ignore real resource constraints, even after writing this).

    Loss of productive capacity meant loss of tax base. Without the ability to tax sufficiently to drive the value of the currency, money became worthless.

    At this point Germany had no choice but to turn to the printing press to obtain foreign currencies to satisfy the obligations imposed by the Allies (obligations they promised would not be imposed if Germany surrendered, by the way).

    Now you answer my question:

    What period of time must pass before you take your Reinhart & Rogoff book and the above paper from Hamilton et al, put them to the side and reconsider your assumptions? How many years and how much “debt” (as you call it) must be racked up without an apocalypse? For how long must interest rates be whatever the Fed makes them, rather than what you believe markets should make them?

    Or do you remain on the Austrian path of “I don’t know when it will happen, but I know it will”?

  • TastyBits Link

    @Ben Wolf

    An apocalypse caused by Fed printing money will occur in 2008. The financial house of cards built upon this counterfeit-like money will begin to collapse. The consequences can either be resolved immediately, or it can be dragged out over many years.

  • France and Belgium confiscated the Ruhr in 1922, robbing Germany of a massive portion of its productive capacity (Steve Verdon will within seconds insist I ignore real resource constraints, even after writing this).

    What was that blubbering you were carrying on about accuracy of predictions?

    By the way, what tipping point were you referring too in the article? The 80%?

  • Loss of productive capacity meant loss of tax base. Without the ability to tax sufficiently to drive the value of the currency, money became worthless.

    Right, it had nothing to do with printing money.

    Oh wait, then the Weimar Republic issued a new currency things remained stable. Did they get the Rhur back? No. Did the ability to tax change? Not that I know of.

    The Rhur was also occupied well after the start of German hyperinflation. And it wasn’t given back until after the German currency was stabilized.

    As to why losing the Rhur was bad, it meant that Germany did have less resources that they could have, in theory, used to trade for foreign currencies to pay reparations. Did it make a bad situation worse? Yes. Was it the cause of German hyperinflation? No.

    At this point Germany had no choice but to turn to the printing press to obtain foreign currencies to satisfy the obligations imposed by the Allies (obligations they promised would not be imposed if Germany surrendered, by the way).

    Your grasp of the historical facts is sadly lacking. The Rhur was occupied in early 1923 (January). Germany issued a new currency stabilizing it in 1923 (November). The Rhur was “given back” to Germany in 1925 (August)!

    Given this, your narrative kind of falls apart as an explanation for German hyperinflation.

  • How many years and how much “debt” (as you call it) must be racked up without an apocalypse? For how long must interest rates be whatever the Fed makes them, rather than what you believe markets should make them?

    So we can sum up your objection to Hamilton in a similar fashion to the way Hamilton replied to Krugman et. al.:

    It hasn’t happened yet, so it can’t!

    Brilliant.

  • Drew Link

    Good news !! Inflation is a myth.

    Not to diminish Hamilton, but all he is saying is the analog of the corporate concept of debt capacity which has two dimensions: debt service and total leverage. I know some who want to say a sovereign can simply print money to solve the limits of both, but it reminds me of a sales oriented CEO we had who proposed a brilliant solution to the constraints debt capacity was placing on him: just skip capex in the fixed charge calculation and go get more sales. Presto!! Remember the Monty Pythin skit “How to Do It?”

    This notion is similar to the min wage-ites. The obvious question is “if its that easy why stop at $9/hr, how about $250?” Now everyone is rich!

    And if printing money has no consequences why not just print about 30 million barrells full of hundreds and give it to the poor? Presto-chango! No more poverty. Damn. Why hasn’t anyone thought of that before? Hell, let’s go all in. Print a bunch of money and a mansion for everyone. Why should Tiger Woods have all the fun?

    Hey, I’m on a roll. Print money and give it to poor Mexicans? No more immigration problems. And how about printing it and fixing the African continent?

    BTW – have I told you about the perpetual motion machine I’m perfecting in my basement? Its secret for now, but I’m putting the finishing touches on it and am going to market it all over the universe after I perfect travel at the speed of light next month.

  • PD Shaw Link

    I believe Germany’s reparations were in commodities, gold and coal. The Ruhr was seized to get the coal when coal payments stopped. The gold had to be acquired largely on the international market, so Germany could not inflate its way to payment.

    The Wiemar government had massive financial obligations to transfer to a peacetime economy and care for the war injured. It never had any legitimacy to raise taxes because the government was seen as having been created by a “stab in the back” and tax increases were widely seen as needed for reparations, not for the other substantial domestic problems. The politicians pursued a policy of conflating its domestic problems with reparations to try to convince Britain and France to modify reparations, particularly cultivating Britain’s desire for trade.

    Essentially, the government put the gun to its own head and asked for help, but only when it realized how awful hyperinflation was took steps to establish a new gold-backed currency at the same time it got some concessions on flexibility, but not amount, of reparations. Thus, they reinforced the conflation of reparations with fiscal policy for the republic’s enemies, handed the gun to the communists and the nationalist to fight over who got the corpse.

  • PD,

    My reading is that is what they ended up with, but early on it was based on either gold or foreign currencies. That latter is what got Germany into trouble. They’d print marks to buy the foreign currency and that is what started the inflation. As inflation worsened there was a summit to deal with the issue. The summit failed and that is what triggered hyperinflation.

    It is what can happen with faith in a fiat currency fails. That is another thing that I don’t think the chartalists/MMTers deal with, or if they do I haven’t seen much discussion of it. Maybe Ben can offer comment on that (and to be perfectly clear, if MMT does deal with this, I’d like to know…honest).

    I think Germany then started making reparation payments in commodities, and their failure to pay on time prompted the occupation of the Ruhr.

    And to counter Ben’s point about industrial base even more, keep in mind very little of the war was fought on German soil. Much of their industry was still intact and based on physical plant and capacity were probably one of the better off countries.

    Another thing Germany did was finance the war via debt whereas the allies used more taxation. Part of the reason was due to Germany being less of a cohesive “unit”–i.e. from what I’ve read the various “states” were more autonomous than say in France or England.

    Essentially, the government put the gun to its own head and asked for help, but only when it realized how awful hyperinflation was took steps to establish a new gold-backed currency..

    No, the Rentenmark was backed by mortgages and land. It also wasn’t legal tender, but it was used for foreign exchange purposes and it did stop the devaluation of the mark, almost instantly. Eventually a new form of legal tender was issued.

    I think one of the big points to take away from this is that hyperinflation is not just form of inflation. That is it is not a smooth continuum. This is a point, I think, Dave has made here. Hyperinflation can happen quickly and have devastating consequences. That is why I find the MMT and Krugman’s views on the debt, deficits, and monetary policy so troubling. They strike me as too sanguine on the issue.

    Ben,

    Your harping on the “tipping point” and “reading the article” that you refuse to respond too paints you as a fool. Yeah the article says 80% and yeah, the U.S. is past that point, as is Japan. But for fuck sake man, that is the average number. Note they did their analysis with a fixed effects model. So the actual tipping point for any individual country can deviate from the 80%. Hamilton went over this point in his blog post.

    So my rejoinder to you is, learn some fucking statistics.

  • PD Shaw Link

    Steve V is correct that the Rentenmark wasn’t backed by gold, but by other assets. The success of the Rentenmark in miraculously stabilizing prices strongly supports the conclusion that is was a lack of political will that was the source of the crisis, not economic fundamentals.

    I think its also worth pointing out also that most of the war belligerents experienced very high levels of inflation in the immediate post-war period (that may be the source of Ben’s confusion). I think the belligerents used inflation during the war to make it easier to direct resources into the war effort (hidden tax), and then after the war state controls were weakened and resources were redirected back into the “normal” productive economy.

    Steve V is correct that the war was largely (entirely?) fought outside Germany, which means that it did not face the type structural damages that other countries faced. It did have almost a million disabled veterans, almost a million orphans and a few hundred thousand war-widows. They all received government pensions (the federal government’s second largest expenditure to reparations), which were very hard hit by inflationary policies that were partly created to pay for the pensions.

  • The success of the Rentenmark in miraculously stabilizing prices strongly supports the conclusion that is was a lack of political will that was the source of the crisis, not economic fundamentals.

    Not entirely. Part of any modern monetary system these days is faith…faith in the value of the currency. Why is $1 worth a $1? Because we believe it is worth $1…we have faith…faith that the government isn’t going to “print” a crap ton of dollars and render the $1 less valuable than dog crap…I was going to say pebbles, but in the case of Germany a basket of pebbles had more value than the mark.

    Germany (the government) took a giant dump all over that belief in the value of its currency. So not only did the Germans stop believing its value, but so did everyone else. As a result hyper-inflation. So yes, it was political, but the political actions undermined a key economic belief…belief in the stable value of the currency.

    This is why inflation and hyper-inflation are not just different points on a continuum. I’d argue that the difference, using mathematical jargon, is that there is discontinuity. Further, I’d also argue that the discontinuity is not a fixed point anybody can point at and say, “there, go beyond that and we are in really bad trouble.”*

    This is why I find some people’s sanguine nature to debt, deficits and the like so disquieting. It is almost as if they think the U.S. is special and it can’t happen to us. It might be the U.S. is special and it will take more to get us to the point of sudden fiscal deterioration, but I’d rather not find out.

    I think its also worth pointing out also that most of the war belligerents experienced very high levels of inflation in the immediate post-war period (that may be the source of Ben’s confusion).

    I think all the belligerents went off the gold standard during the war, and afterwards many engaged to varying degrees attempts to monetize their debts. Also, this would be the first time many of these currencies attempted to use a fiat currency (i.e. they made mistakes) and these resulted in inflation.

    I think many eventually went back to the gold standard or something like it and that stabilized prices…then came the Great Depression and there (ironically) adherence to the gold standard proved to be disastrous.

    *Note the paper Hamilton points too does not claim to have found the point. If you read it carefully, they discuss a tipping point where countries become vulnerable to rapid fiscal deterioration. Yes, the U.S. has passed the average “tipping point” but later in their paper they also do discuss why the U.S. is “different” than many other countries. This underscores why I have a hard time with Ben and even guys like Krugman. Krugman is a little piece of shit, IMO. He writes these articles that slam others in his profession and then waves around his many accolades as a shield for his contemptible behavior.

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