Perhaps what’s needed in this time of state fiscal crisis is a bit of war mentality — patriotism, solidarity and all that.
That’s our takeaway from a piece of research by Goldman Sachs economist, Saleem Bahaj, who notes that:
When thinking about the longer-term prospects for the debt stock, it is important to bear in mind that there have been occasions in the past when sovereigns have been able to digest high levels of debt and fairly quickly return to a more sustainable debt to GDP ratio. The postwar experience of the US and the UK is a particularly good example. Both countries borrowed heavily to fund their war efforts, and emerged from the conflict with sovereign debt ratios above 100% of GDP — well above in the case of the UK. However, as Charts A and B illustrate, it took just a little over 15 years for both countries to halve their debt levels.
However, it’s not like any of this was down to fiscal austerity, according to Bahaj. Deficits were cut back sharply after the war but the US had a basically neutral net cash flow (funding) requirement over the period while the UK was a net borrower, according to Bahaj.
Instead, he puts the decrease down to two factors:
* First, the post-war period was characterised by relatively low real interest rates compared with the (very) long-term historical average, allowing a smaller proportion of the primary surplus to bear the interest rate costs of the high debt burden. This was in part due to a period of relatively stable inflation, at least in contrast to the period of volatile prices that followed in the 1970s, and in part due to the relatively high saving rates of the 1950s and 1960s.
* Second, it was a period of relatively strong nominal growth. In the US, nominal GDP grew by an average of 6% a year between 1946 and 1960; in the UK, the figure was 6.6%. Table A decomposes the drivers of the change in the debt ratio between the impact of actual borrowing, the increase in real activity and the change in the GDP deflator. Looking at these figures, both economies grew and inflated, rather than saved, their way out of trouble.
Got that? Inflation and GDP growth, not savings.
So spend, spend, spend! Happy fourth of July!
