Matt O'Brien vs. the Chicken Littles Who Think the U.S. Faces an Imminent Debt Tipping Point That Will Turn It into Greece
Matt O'Brien:
No, the United States Will Never, Ever Turn Into Greece: Have you read the opinion section of any newspaper in the last three years? Yes? Then there is a better-than-even chance you have come across some impressive-sounding analyst predict that the United States is "turning into Greece."… As far as scare stories go, this is pretty damn scary. It's also just a story….
[An] 80 percent… [debt-to-annual-GDP ratio] was the bright white line drawn in a recent paper by David Greenlaw, James Hamilton, Peter Hooper and Frederic Mishkin. Greenlaw & Co. ran regressions on 20 advanced economies from 2000 to 2011 to see if there's a relationship between a country's borrowing costs one year and its… debt… the previous one…. They found a link… increasing… debt levels [above 80%] by 1 percentage point of GDP would increase borrowing costs by 4.5 basis points (or 0.045 percentage points)… This is a big deal…. Our gross debt to GDP is already at 102 percent -- enough to send our borrowing costs soaring…. If they are right. They almost certainly are not…. (1) For countries that can borrow in their own currency, like the U.S., higher debt doesn't clearly lead to higher interest rates. (2) For countries that don't control their currencies, like Greece, it's borrowing too much from foreigners (NOT borrowing too much in general) that clearly leads to much higher borrowing costs….
How much of Greenlaw & Co.'s results are driven by euro countries that have completely different debt dynamics than non-euro countries?… 12 of the 20 countries they look at are… part of the euro…. The remaining ones show no signs of anything resembling debt tipping points…. [T]he non-euro countries in red, the core-euro countries in green, and the (later) troubled PIIGS countries in blue… [before 2008 show not] much of any discernible relationship between debt and interest rates. But then Lehman failed, and the world changed. Debt went up and borrowing costs came down -- except for the PIIGS.
I… started by trying to recreate the Greenlaw & Co. result for the entire 20-country sample… I ran a regression with country and time-fixed effects on the non-euro countries -- Australia, Canada, Japan, Norway, Sweden, Switzerland, the U.K., and the U.S. -- from 2000 to 2011. I got coefficients of .00743, .00575, and -0.0695 for gross debt, net debt, and current account, respectively. None of them were statistically significant…. [F]or non-euro countries tells us increasing debt by 1 percentage point of GDP only increases borrowing costs by 1.3 basis points….
But what about Europe's troubled economies? The Greenlaw & Co. results should hold up there, if nowhere else, right? Well, kind of. I ran another regression with country and time fixed effects on the PIIGS… from 2000 to 2011… got coefficients of 0.0843 and -0.9157 for gross debt and the current account. Both were highly significant…. [O]ur equation for the PIIGS tells us increasing debt by 1 percentage point of GDP increases borrowing costs by 8.4 basis points -- but increasing the [five-year average] current account deficit by 1 percentage point of GDP increases borrowing costs by 91 basis points! The PIIGS do have a serious problem, but that problem is borrowing too much from foreigners…. Of course, this isn't exactly new information….
My sample sizes here are so ridiculously small that the results are hardly dispositive. So don't pay attention to the evidence. Pay attention to the lack of evidence. There isn't any evidence that the U.S., or other countries that borrow in currencies they control, face some debt tipping point after which borrowing costs spiral out of control. There isn't even much evidence this is true of Europe's troubled economies. Borrowing costs fell for the PIIGS in 2012 (one year after Greenlaw & Co.'s sample ended), not because those countries reduced their debt burdens, but because the ECB promised to do "whatever it takes" to save the euro. A monetary backstop matters more than the amount of debt. Reducing debt isn't as empirically urgent as we hear.
