Thursday, October 24, 2013

Shiller On Debt

Newly minted Nobel Laureate Robert Shiller is on Project Syndicate talking about the debt to GDP ratio (excerpt):

Debt and Delusion

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…Could it be that people think that a country becomes insolvent when its debt exceeds 100% of GDP?

That would clearly be nonsense. After all, debt (which is measured in currency units) and GDP (which is measured in currency units per unit of time) yields a ratio in units of pure time. There is nothing special about using a year as that unit. A year is the time that it takes for the earth to orbit the sun, which, except for seasonal industries like agriculture, has no particular economic significance.

We should remember this from high school science: always pay attention to units of measurement. Get the units wrong and you are totally befuddled...

...The fundamental problem that much of the world faces today is that investors are overreacting to debt-to-GDP ratios, fearful of some magic threshold, and demanding fiscal-austerity programs too soon. They are asking governments to cut expenditure while their economies are still vulnerable. Households are running scared, so they cut expenditures as well, and businesses are being dissuaded from borrowing to finance capital expenditures.

The lesson is simple: We should worry less about debt ratios and thresholds, and more about our inability to see these indicators for the artificial – and often irrelevant – constructs that they are.

He goes on to diss Reinhart and Rogoff’s findings that the 90% threshold is significant (growth slows across the whole spectrum, not just at the higher end; the debt thresholds chosen were arbitrary), and notes that reverse causality is just as likely – high debt to GDP ratios might be caused by slower growth rather than the other way around.

Prof Shiller is sometimes hard to pin down – he’s obviously not a fresh water economist, but then neither is he a Keynesian. His background is behavioural economics, and his insights are fun to read even if they tend to be unorthodox. He was one of the few to correctly call the demise of the US housing bubble. He doesn’t pull any punches either - I absolutely love this line:

Economists who adhere to rational-expectations models of the world will never admit it, but a lot of what happens in markets is driven by pure stupidity – or, rather, inattention, misinformation about fundamentals, and an exaggerated focus on currently circulating stories.


  1. I too also love the quoted statement that ultimately the vast majority of market participants are too stupid and ill-informed to make rational decisions, and have been using his (and Taleb's) books as my starting point for trying to learn economics and understand the markets in my free time.

    The unfortunate fact is that all too often the combined effect of the actions of irrational market participants (who all believe they are rational) create self-fulfilling prophecies, and it takes a great amount if discipline to ensure that one is able to distinguish between the changes in fundamentals and changes caused by the herd effect.

  2. It depends........Singapore got very high debt......ON PAPER......Why? Because singapore got to issue bond to CPF........See isn't that services rendered by the government to its citizen? CPF used to build massive public housing.....that house more than 80% of its citizens......still got more HDB flats left for PRs including Malaysian.........

    Compared it to Malaysia, get my drift

    1. looes74,

      Thank you for that info on HDB - it was the missing piece of the puzzle and nicely clears up the SG debt/investment return puzzle for me.

      However, I am still not sold on SG's convoluted financing/social security arrangements.

      1. By law, the government is only required to pay a minimum 2.5%/4% (depending on account type) on bonds issued to CPF, and that in fact is the rate that is provided to CPF contributors. Contrast that with our EPF which conducts its own investments, and has managed to pay contributors 6%+ over the past couple of years. This is financial repression of the first order.

      2. The numbers don't match - CPF contributions reached SGD280b in 2012 while actual debt issued for CPF is about SGD320b. Monetary debt (the balance) is SGD60b for a grand total of SGD380b as at the end of 2012. Outstanding government loans to HDB is only in the region of SGD49.5b, while the government account at MAS plus deposits in banks is about SGD180b.

      Where is the remaining SGD150b?

      3. Government loans to HDB are not used to finance housing development, but to finance mortgages to HDB applicants at concessionary rates pegged to CPF returns (HDB deficit operations are financed through government grants, which isn't actually very large). In other words, cheap mortgage financing in return for low returns on retirement savings. One could argue this is effectively a wealth transfer from the rich to the poor - except that under the current environment, HDB loans aren't actually cheap (bank mortgage rates are lower) while the rate of return on CPF contributions are below the rate of inflation. In addition, the low returns apply to all contributions (SGD320b), but HDB loans are a fraction of that amount (SGD49.5b). And any HDB applicant still has to finance the downpayment from their CPF savings.