A new study on public debt presented at the recent University of Chicago Booth School of Business monetary policy forum in New York has highlighted “tipping point dynamics” that can occur to countries with high debt loads.
The study entitled, Crunch Time: Fiscal Crises and the Role of Monetary Policy, identifies debt equivalent to 80 percent of gross domestic product (GDP) as the critical point where an economy becomes highly vulnerable to disruption. Focusing on the recent experience of advanced economies, the authors note that “a country can quickly move from the group without problems to the group that faces nearly insurmountable problems if its debt rises significantly above 80% of GDP.”
As they pass the tipping point, countries are likely to encounter problems such as higher sovereign interest rates, the crowding out of private investment, and even limits on the flexibility of government to respond to future economic or national security crises.
The severity of negative consequences of passing the debt tipping point is ultimately determined by the policy environment. Policies that favor economic freedom enhance economic resilience and create and facilitate an economic and business environment that reduces the risks of debt. As analyzed by Ambassador Terry Miller and economist J. D. Foster in The Heritage Foundation’s 2012 Index of Economic Freedom:
The permanent increase in the ratio of public debt to GDP…is prima facie evidence of policy failure. The high levels of public debt accrued in many countries thus reflect years of bad public financial management and the cumulative impact of poor policy choices. Such poor policy choices are highly likely to have restrained economic freedom as well…
Historical data from the Index of Economic Freedom show a clear negative relationship between the accumulation of debt and economic freedom. In general, countries with lower levels of public debt as a percentage of GDP tend to enjoy high levels of economic freedom…. There is an even stronger negative relationship between debt-to-GDP ratios and economic freedom for advanced economies than there is for developing economies.
It is no coincidence that America’s debt burden has surged as its economic freedom has declined to its lowest level since 2000. The remedy is straightforward: Now is the time to reaffirm the conservative principles of limited government, free enterprise, and rule of law, and to reinforce our traditional commitment to freedom and opportunity.
Redoubling our efforts to change America’s current course begins right here.