Reinhart, Rogoff: Debt Endangers Growth

"...At what point does indebtedness become a problem? In our study “Growth in a Time of Debt,” we found relatively little association between public liabilities and growth for debtlevels of less than 90 percent of GDP. But burdens above 90 percent are associated with 1 percent lower median growth.

Our results are based on a data set of public debt covering 44 countries for up to 200 years. The annual data set incorporates more than 3,700 observations spanning a wide range of political and historical circumstances, legal structures and monetary regimes.

We aren’t suggesting there is a bright red line at 90 percent; our results don’t imply that 89 percent is a safe debt level, or that 91 percent is necessarily catastrophic. Anyone familiar with doing empirical research understands that vulnerability to crises and anemic growth seldom depends on a single factor such as public debt. However, our study of crises shows that public obligations are often hidden and significantly larger than official figures suggest.

Creative Accounting Devices

In addition, off-balance sheet guarantees and other creative accounting devices make it even harder to assess the true nature of a country’s debt until a crisis forces everything out into the open. (Just think of the giant U.S. mortgage lenders Fannie Mae and Freddie Mac, whose debt was never officially guaranteed before the 2008 meltdown.)

There also is the question of how broad a measure of public debt to use. Our empirical work concentrates on central-government obligations because state and local data are so limited across time and countries, and government guarantees, as noted, are difficult to quantify over time. (Until we developed our data set, no long-dated cross-country information on central government debt existed.) But state and local debt are important because they so frequently trigger federal government bailouts in a crisis. Official figures for state debts don’t include chronic late payments (arrears), which are substantial in Illinois and California, for example.

Public and Private Debt

Indeed, it isn’t unusual for governments to absorb large chunks of troubled private debt in a crisis. Taking this into account, chart 1, attached, shows the extraordinarily high level of overall U.S. debts, public and private.

In addition to ex-ante or ex-post government guarantees and other forms of “hidden debts,” any discussion of public liabilities should take into account the demographic challenges across the industrialized world. Our 90 percent threshold is largely based on earlier periods when old-age pensions and health-care costs hadn’t grown to anything near the size they are today. Surely this makes the burden of debt greater..."

at  http://www.bloomberg.com/news/2011-07-14/too-much-debt-means-economy-can-t-grow-commentary-by-reinhart-and-rogoff.html