Arnold Kling  

A Fable of Two Countries

Bias Against Speculation?... A Sentence that I Doubt...

Once, there were two countries, I and U. Each had GDP of $100. Each had nominal GDP growth of 4 percent.

Country I was a good country, with government debt of only $60, taxes of $20, and spending on everything other than interest payments of only $19.

Country U was a bad country, with government debt of $80, taxes of $20, and spending on everything other than interest payments of $25.

Oddly enough, the bond market vigilantes were mixed up. They charged a high interest rate (7 percent) to country I and a low interest rate (2 percent) to country U. Thus, country I's ratio of debt to GDP kept growing and growing. Interest on the debt was $7, other spending was $19, and taxes were only $20, so it had an overall deficit of $6. Its GDP only grew by $4, so its debt rose by $2 more than GDP. Country I had a sovereign debt crisis.

Country U did not have a sovereign debt crisis. Yet.

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CATEGORIES: Fiscal Policy

COMMENTS (11 to date)
steve writes:

What is the history of these two countries? You would not buy a bond w/o that information.


Z writes:

What about country I's inability to control it's own money supply?

Whilst all of U's debt is denominated in a currency it wholly controls?

DjangosRevenge writes:

Italy and the United States?

Phil writes:

How can country I be called the "good" country if it had a deficit larger than the "bad" country's?

Interest payments count too. If "I" has to pay a higher interest rate, it needs to spend less elsewhere, or tax more to cover those interest payments.

Judging a country on "Spending on everything other than interest payments" is like judging a consumer on "spending on everything other than cocaine." Why should interest, or cocaine, be exempt from the evaluation?

Perhaps I'm missing the point?

Hugh writes:

My two cents? It's just a question of timing. Look out for first J and then U to follow I over the next few years.

jb writes:

personally, I suspect we'll see some trillion dollar platinum coins being minted before too long, specifically to wipe out U's debts.

Dave Schuler writes:

It can't be Italy and the U. S.: I and U have the same GDPs.

I give up. Is this just a hypothetical or do you have specific countries in mind?

caveat bettor writes:

@Dave Schuler: GDP per capita might be a better proxy. Let's call it about 40,000 USD. Give it one more look.

Jeff writes:

I is for Ireland

Dave Schuler writes:

Ireland's per capita GDP is about 20% lower than U. S.; Italian GDP per capita about 50% lower.

I repeat: is this a hypothetical?

I would also suggest that size matters. GE, whose revenues per employee are about a half million, probably pays a lower interest rate on its debt than a cardiac surgeon whose income is a half million.

lurkingowl writes:

Um, 7% of $60 is $4.20, right? The numbers have to be skewed more to make your point. And the vigilantes have to stay out in force for quite a while even with the 6% (2% vs GDP) deficit (~10 years before I catches up with U.)

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