Paul Krugman's recent piece "Learning From Greece" is more right than wrong: Hitting the fiscal and monetary brakes too soon still poses a risk to the recovery "” and the nation's fiscal health.
But in arguing against premature tightening, Krugman has also created an impression that our budget plight is much less worrisome than it is.
In the column, Krugman recounted the U.S. experience just after World War II, when debt reached a record-high 122% of GDP "” a level far above that which many economists now say is dangerous.
Krugman then explains that dealing with that debt of $271 billion at the end of 1946 didn't require any drastic measures; rather the country just grew its way out of the problem. A decade later, he says, the debt was marginally bigger, but the economy had nearly doubled in size in dollar terms.
But Krugman is more wrong than right to suggest that the same recipe "” real growth and inflation "” is the answer to solving our problems once again.
Here's what he left out.
First, the applicable facts:
The 122% of GDP cited by Krugman was the gross federal debt, which includes interagency government borrowing. Public debt reached a record 109% of GDP in 1946, or $242 billion. A decade later, public debt had fallen to $222 billion, or 52% of GDP.
Why did the debt fall? An important fact that Krugman left out: the federal budget was in surplus for five of the next 10 years after 1946.
By contrast, public debt would nearly triple from $7.5 trillion at the end of fiscal 2009 to $20.3 trillion in 2020 under President Obama's policies, the Congressional Budget Office projects. And that assumes a reasonably solid recovery with the jobless rate falling to 5.3% by 2014 and no recession in the decade ahead.
The big difference, of course, is that the run-up in debt in the 1940s was due to a temporary war. Spending hit $93 billion in 1945 and by 1956 was still only $71 billion.
Our problem now, besides trying to climb back from a deep recession, is that spending will only go up, up and away on our current path. CBO projects that outlays will hit $5.7 trillion in fiscal 2020, up 61% from 2009 levels.
So economic growth, while important, is neither a cure nor a cause for complacency about our budget challenges.
While Krugman is certainly correct that deflation would make it much harder to deal with our debt burden, his suggestion that we can inflate our debts away also leaves out critical facts.
Robert Samuelson's acclaimed book, "The Great Inflation and Its Aftermath," tells the story of how well-intended policy led to an unintended inflation spiral in the 1970s and produced great economic upheaval.
"Then, a little inflation seemed unthreatening; but a little led to a little more, and little more led to a lot," Samuelson wrote.
It turns out that the 70s isn't the only post-war example of moderate inflation accelerating to double-digit price increases. It also happened in 1947, as economists Joshua Aizenman and Nancy Marion note in "Using Inflation to Erode the U.S. Public Debt."
That burst of inflation was short-lived. But the world has changed in ways that could make inflation more damaging to the U.S. economy.
Back then, the government was able to carry a heavy debt burden without too much trouble because Americans had bought up War Bonds and willingly accepted below-market, ultra-low interest rates out of patriotic duty.
Even with record debt levels, interest payments peaked at 1.8% of GDP.
But now that foreign creditors hold close to 50% of U.S. debt vs. zero at the end of World War II, interest rates will be set in the global marketplace.
"Accelerating inflation had limited global implications at a time when the public debt was held domestically and the U.S. was the undisputed global economic leader," Aizenman and Marion wrote.
Today, on the other hand, accelerating inflation could aggravate tensions with foreign creditors and lead to less reliance on the dollar, they warned.
What is more, the average maturity of Treasuries is now about 4 years vs. 9 years after the war, meaning that debt has to be rolled over more frequently and interest costs are more liable to spike if inflation concerns push up yields.
CBO projects that interest payments will soar from $209 billion in 2010 to $916 billion in 2020. In GDP terms, debt service would rise from 1.4% to a record 4.1%.
But even that might be too optimistic. An analysis that CBO did last year for Rep. Paul Ryan, R-Wis., found that if 10-year Treasury yields average the same 6.6% rate that they did from 1991-2000, that would raise 10-year federal deficits by an extra $1.2 trillion over CBO forecasts.
Double-digit yields could add $5 trillion to projected deficits, CBO said.
The other big omission from Krugman is any sense that our current path toward high indebtedness, if not proactively addressed, will hurt our standard of living and begin to eat away at the foundations of government.
Consider that over the next decade, CBO projects that interest on the debt will increase by $7 for every dollar of extra spending on every other program budgeted by Congress on an annual basis. That includes spending on everything from defense and homeland security to education, transportation, the environment, science and veterans' health.
From 2014 to 2020, on our current path, roughly 44 cents of every extra dollar collected in tax revenue would be needed to cover interest payments.
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