Nobel Laurieate Krugman: The Debt Is Not a Crisis, Risk of Depression IS

Last year Paul Krugman warned that we seemed to be heading into the “Third Depression” — by which, he explains, he meant we were in a prolonged period of economic weakness. The signs are all around us that the "recovery" is a jobless one. The rate of growth in jobs will take years to hire back all who have been laid off. In fact, federal and state workers and teachers are now facing lay off in the next fiscal year. 

Do we really want to face a "lost decade"? Or are we willing to stimulate the economy before this gets any worse?

Debt Arithmetic
The whole tone of current discussion about deficits is one of urgency: deficits must be brought down now now now or crisis looms. Where is this coming from? Not from the arithmetic.
The way the story is often told, deficits mean higher debt, which means higher interest payments, which can mean a spiral into bankruptcy. And qualitatively that’s not wrong. If you put numbers to it, however, for countries that are not facing huge risk premia, the spiral is very, very slow.
Here’s a sample calculation.
The latest IMF Fiscal Monitor predicts that general government in the US — that’s federal, state and local combined — will run a deficit of 7.5 percent of GDP next year, and that net debt will be 75 percent of GDP.
So how fast would the debt spiral be going?
You need to bear in mind that growth and inflation limit the rate of rise in the debt ratio. Suppose that we have 4 percent nominal GDP growth, which is actually low by historical standards. This shaves 3 percentage points off the rise in the debt/GDP ratio. So a year later, given those numbers, debt rises by 4.5 percentage points of GDP.
What’s the interest burden of that rise? At minimum we should correct for inflation, so use the TIPS yield. That’s currently below 1, but let’s be pessimistic and call it 2. Even so, the added interest burden is less than one-tenth of one percent of GDP.
So even with substantial deficits, the pace of long-term budget worsening is very slow. If it’s a debt death spiral, it’s a slooooowww motion death spiral.
But, say the critics, psychology can change suddenly, sharply raising those interest costs. The question then is why psychology should change. Investors can do the same arithmetic I’ve just done; why should they panic over a small rise in the interest burden?
Now, investors might well panic over signs of political deadlock — but that could happen regardless of the current year’s deficit.
Still, Serious People tell us that investors will turn on us unless we slash the deficit immediately — and they know this because, well, um …
As I’ve often written, we’re in a strange state now where people who actually take textbook economics and simple arithmetic seriously are seen as dangerously radical and irresponsible, while people who believe in invisible bond vigilantes and confidence fairies, who claim to know what the market will want even though there’s no sign of that desire in current asset prices, are viewed as Very Serious.
Anyway, the arithmetic of debt is much less scary than you might think.

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Republican Medicare Cuts

Even without Dubya, the Republicans are still into Doublethink. It is, even when it isn't, no means yes, and "No to Medicare Cuts!" means bigger Medicare cuts.

Republican Medicare Cuts - Paul Krugman Blog - NYTimes.com:

"So, Newt Gingrich and John Goodman say,

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Don’t cut Medicare. The reform bills passed by the House and Senate cut Medicare by approximately $500 billion. This is wrong.

Leave aside the mind-killing irony of Newt Gingrich — New Gingrich! — denouncing Medicare cuts. What are Republicans themselves proposing?

Well, Rep. Paul Ryan’s Roadmap for America’s Future calls for the eventual elimination of Medicare as we know it, replacing it with a system of vouchers that would, eventually, account for a steadily declining share of GDP. But what about the next decade? Mr. Ryan’s release says that it

Strengthens the current program with changes such as income-relating drug benefit premiums to ensure long-term sustainability.

What does that mean? The CBO, helpfully, translates (pdf):

People who are age 65 or older in 2020 and other existing enrollees at that time would continue to be covered by the current program, although some higher income enrollees would pay higher premiums, and some program payments would be reduced.

In other words, Medicare would face cuts. And the CBO’s detailed analysis provides an estimate of those cuts. I’ve taken the table comparing projected spending with baseline as a share of GDP (xls), and scaled it up using the CBO’s projections of GDP. What I get is an estimated cut in Medicare spending over the next decade of about … $650 billion.

So, cutting Medicare by $500 billion is wrong — support Republicans, who want to cut it by $650 billion!"

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