Lucy Hunt presentation on Historical Precedents for Persistently Low U.S. Inflation from CFA SOCIETIES TEXAS ANNUAL INVESTOR SYMPOSIUM

Friday, February 14, 2014
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The Impact of High and Growing Government Debt on Economic Growth

Checherita and Rother investigated the average effect of government debt on per capita GDP growth in twelve euro area countries over a period of about four decades beginning in 1970. A government debt to GDP ratio above the turning point of 90-100% has a “deleterious” impact on long-term growth. In addition, they find that there is a non-linear impact of debt on growth beyond this turning point. A non-linear relationship means that as the government debt rises to higher and higher levels, the adverse growth consequences accelerate. Results across all models “show a highly statistically significant non-linear relationship between the government debt ratio and per-capita GDP for the 12 pooled euro area countries included in their sample.”

Moreover, confidence intervals for the debt turning point suggest that the negative growth rate effect of high debt may start from levels of around 70-80% of GDP. Due to  these findings, Checherita and Rother write this “…calls for even more prudent indebtedness policies.” Checherita and Rother make a substantial further contribution by identifying the channels through which the level and change of government debt is found to have an impact on economic growth: (1) private saving, (2) public investment, (3) total factor productivity and (4) sovereign long-term nominal and real interest rates. Cristina Checherita and Philipp Rother, The Impact of High and Growing Government Debt on Economic Growth, An Empirical Investigation for The Euro Area, European Central Bank working paper, Number 1237, August 2010.

Two Major Studies Analyzing Effects of Private Overindebtedness

1. In “Too Much Finance” Jean Louis Arcand, Enrico Berkes, and Ugo Panizza, published by UNCTAD in March 2011, find a negative effect on output growth when credit to private sector reaches 104 to 110 percent of GDP. The strongest adverse effects are for credit over 160 percent of GDP.

2. “The Real Effects of Debt” by Stephen G. Cecchetti, M S Mohanty and Fabrizio Zampolli of August 2011, published by the Bank for International Settlements in Basel, Switzerland determine “beyond a certain level, debt is bad for growth”. These negative consequences or what the BIS economic advisor Cecchetti refers to as the point at which debt levels turn “cancerous” occur at 175% (90% for corporations and 85% for households) just slightly higher than the UNCTAD study.

See full PDF on Historical Precedents for Persistently Low U.S. Inflation: via CFA Institute