A Theory of Debt Accumulation and Deficit Cycles


I talked about my ideas in this paper to colleagues, professional economists, policymakers, and also in blogs. It’s time I begin present the paper before academic audiences. Today I start with a short presentation during the Swiss Finance Institute research days in Study Center Gerzensee.

The issue: many advocate the thesis that a large government debt might hinder growth. For example, too much debt may signal upcoming tax increases, which discourages new investments. Do you remember Krugman v. Reinhart & Rogoff controversy? Reinhart & Rogoff theses seem to have influenced policymakers in the process of dealing with the European debt crisis of the early 2010s. In Reinhart and Rogoff own words:

“Our 2010 paper found that, over the long term, growth is about 1 percentage point lower when debt is 90 percent or more of gross domestic product.”

Carmen M. Reinhart and Kenneth S. Rogoff, April 26, 2013, The New York Times

Do such numbers exist? Paul Krugman believes they don’t. More recently, Alberto Alesina, Carlo Favero and Francesco Giavazzi have shifted the debate on how to cure debt-sickness in their book on Austerity: When It Works and When It Doesn’t (2019, Princeton University Press). To cut a long story, they collect evidence and argue that austerity programs relying on cutting expenses are much less painful and, sometimes, even conducive to growth, than austerity plans relying on increasing taxes.

I ask a related question. Too much debt might lead to default, and austerity plans might be unavoidable at some point. When? My answer is that such austerity plans might arrive too late to avert a crisis.

As I explained in a previous post, I am not claiming primary deficits are necessarily wrong.

Slides are here. Paper will be posted here before the end of the summer.

Keywords: National debt, fiscal tipping points; austerity; credit spreads.