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Debt and Delusion

The fundamental problem for much of the world today is that investors are overreacting to debt-to-GDP ratios, fearful of some magic threshold, and demanding fiscal-austerity programs too soon. We should worry less about debt ratios and thresholds, and more about our inability to see these indicators for the often-irrelevant constructs that they are.

NEW HAVEN – Economists like to talk about thresholds that, if crossed, spell trouble. Usually there is an element of truth in what they say. But the public often overreacts to such talk.

Consider, for example, the debt-to-GDP ratio, much in the news nowadays in Europe and the United States. It is sometimes said, almost in the same breath, that Greece’s debt equals 153% of its annual GDP, and that Greece is insolvent. Couple these statements with recent television footage of Greeks rioting in the street. Now, what does that look like?

Here in the US, it might seem like an image of our future, as public debt comes perilously close to 100% of annual GDP and continues to rise. But maybe this image is just a bit too vivid in our imaginations. Could it be that people think that a country becomes insolvent when its debt exceeds 100% of GDP?

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