Yes. The ratio rises–as it clearly did in the US case, from 150% of GDP at the end of 1929 to 215% by mid-1932. During that time nominal debt would have fallen slightly, but real GDP and prices fell much more. Hence the ratio blew out. This I term Fisher’s Paradox; to quote him “The more debtors pay, the more they owe”.

Of course, there’s ultimately a turning point–or an extraneous event that rights the system, such as the New Deal. Or the Second World War…

I wanted to post this on your ‘about’ page but I seem unable to comment there. I’m not sure if I understand the fundamentals and I wanted to clarify it, I think this article is an appropriate place.

Traditionally inflation referred to the money supply, and meant an increase in the money supply, when now it might mean ‘rising prices’ and not retain its monetarism roots. If an argument was made that a sudden doubling of prices and wages across the entire economy occurred, and that it would change ‘nothing’ - then we haven’t taken into consideration debt (and perhaps also savings).

The problem with debt, is that the arrangement to pay it back was made before the event which doubled prices and wages. So if you are a creditor (like a bank) suddenly you are facing the prospects of having your loans repaid with devalued dollars. Or if you are a first home buyer with a mortgage you might jump for joy if you’re on a fixed interest rate loan!

The level of debt being treated as a stock (constant) and the amount of money in circulation as a flow (not constant). Or interest rates as a flow?

This is the ’soft landing’ scenario if the government drives up inflation and wages, it just has to be controlled so that it doesn’t end up as hyperinflation.

If however interest rates and inflation are kept low, then to service the debt, because peoples wages are not rising, the money being used to service the loans is not in circulation (or we view it as the additional credit which was circulating dissappears), and suddenly a huge amount of aggregate spending dissappears, and this is the start of a debt deflationary spiral.

In either case, debt is really a ‘ceiling’ in a stable economic environment because debt cannot outstrip wages - so very high debt levels indicate that the economic environment is about to change.

Is that the general idea of why stocks and flows are important and why debt is ‘carbon dioxide’?

I’m curious, where you wrote “there are feedback effects in the economy that can mean debt to GDP ratios fall even when, ultimately, borrowers try to reduce their exposure to debt”, did you mean that the ratio RISES from the feedback effects (as GDP falls faster as a result of repayment/default/capital allocation even while outstanding debt is reduced)? Or have I misunderstood?

Some readers may be interested in a new site (still in its infancy) at http://bubblepedia.net.au - I’m sure discussions involving the debt bubble will become central to questions raised there.

regards, F.

It’s a good question, not an ignoramus one. Inflation does undoubtedly have distributional effects, but the mileau in which it is experienced determines whether these are seen as bad or not.

In the post-World War II environment, when the world had been precipitated into that conflict by the Great Depression, policymakers were easily persuaded that inflation was a minor problem: if guaranteeing higher employment meant higher inflation as a by-product, so be it.

However we then went through a period of roughly 20 years of relatively low inflation AND low unemployment–and the memories of the Great Depression receded.

When the next outbreak of inflation occurred, it coincided with an increase in unemployment–and economists of conservative persuasion (most notably Milton Friedman) dreamed up theories to “explain” this twin phenomenon. Since both occurred at once, arguing that high inflation prevented high unemployment looked rather limp.

The horror scenario put forward then was of ever-increasing inflation: keep it up and we’ll return to the Wiemar (I hope I got the spelling right there!) Republic days of hyper-inflation–like that which Zimbabwe is in right now–of 100,000% inflation per year.

That, clearly, is a horror; but it was not the path we were on in the 1970s, as inflation peaked at around 17% p.a. (below the maximum recorded in the Korean War Boom).

The theoretical and policy product of that period nonetheless was a resurgence of the neoclassical perspective on the economy–that it was self-equilibrating, and attempts by government to manipulate it would fail to move “real” variables like unemployment, and only cause inflation.

In that guise too, the taming of inflation became the “one trick pony” of the economics profession: we had the Vockler squeeze that drove real interest rates sky high, and inflation was driven out of the system (at the cost of a prolonged recession, especially in the UK where similar policies were followed rigorously by the Thatcher Government).

Then the many post-80s booms began; booms and busts with peaks in unemployment heading higher, but lows in unemployment heading lower. Finally this long boom began in the mid 90s, and economists could bask in the reflected glory of what appeared to be a new benign confluence of low unemployment and low inflation. This showed, of course, that their mantra worked: “keep inflation low” at all costs, and the real economy will take care of itself by converging to equilibrium.

So that’s a long-winded explanation of why inflation is seen as a bad thing–in addition to the actual bad effects of discouraging savings by devaluing cash holdings, etc. (there is a comment on cash and inflation that I have to respond to by a new member), etc.

Of course, from my debt-dynamics perspective, this long boom was the product of a borrowing binge, and the 1970s confluence of high inflation and high unemployment was due to the bursting of a debt bubble back then–which is clearly apparent in my Debt/GDP graph.

But maybe I should try the sixpack of beer as a stage experiment next time I’m on podium with a conventional economist!

Maybe someone from the RBA would like to show that stocks don’t have consequences by drinking a 6 pack quickly, always an interesting experiment in pharmacokinetics or for engineers simple process kinetics. Then compare the effects to drinking same one beer per day over a week.

“The only way that debt levels can be reduced is if income is redirected from either consumption or investment into debt
reduction. This is the key reason that the debt to GDP ratio is important: it tells us how much of income would be needed to reduce debt, and how long such a reduction would take.”

You’ve now given a precise meaning to that, which I will take advantage of in future.