Wednesday, January 30, 2013

How And If Debt Will Change Anything

The Economist's Free Exchange blog has been looking at attempts to inject the behavior of financial intermediaries into macroeconomic modeling. A recent post introduces a paper by Markus K. Brunnermeier and Yuliy Sannikov (Link) which takes a hard look at the tale the post-Bubble Japanese economy has to tell about treating the financial sector as a afterthought or as a fundamental element.

I am trying to wrap my head around two items in the paper.

The first is the statement "Of course, aggregate total debt in a closed economy is zero." This is both obvious and salient for an economy such as Japan's where so much of all forms of debt are held domestically.

The second is this pair of graphs of the aggregate debt levels in the economies of the United States (left) and Japan (right).

What the right hand graph shows is that total debt in Japan is over 600% of GDP whereas in the United States the figure is less than 300%. The right hand graph also shows a massive shift in the creation of debt from the non-financial corporate sector (deepest blue) to the government (lightest blue) after 1991.

No surprises here either.

What I am trying to understand is where is the ceiling -- the point where the various actors inside a largely closed economy say to each other, "We cannot go on borrowing like this from each other anymore"?

Put another way, with Japan having zero incentive to foreclose upon itself, is there a percentage of GDP where the total aggregate liability becomes significant, save as a psychologically depressing factor?

Later - Reader MK points me to the long, graph-rich look at Japan's economy published by John Makin of the American Enterprise Institute (Link). While Makin tries, as most Americans writing on Japan's economy do, to influence ongoing fiscal and monetary policy battles in Washington, the paper gives a comprehensive, if pessimistic view of the likelihood of Abenomics changing Japan's overall economic situation.

One question: how is it that an economist who argues so strongly for the importance of large-scale, inevitably deficit-enlarging government spending, holds a chair at the American Enterprise Institute?

Image courtesy: Brunnermeier and Sannikov (2012)

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