The budget deficit is the change in the nominal face value of public debt. It is roughly unique (as far as I know) being the change in a quantity which is not corrected for inflation. We do not usually talk about nominal GDP growth or nominal wage growth. The sustainable deficit increases one for one in debt*inflation, so the term should be removed if one is thinking of long term sustainability.
I think the reason the absurd number is used is that it is high, so deficit hawks, deficit peacocks, and very serious people like it. Here is the value of US Federal Government debt in 2nd quarter 2023 dollars (deflated with the GDP deflator)
Notice that it used to increase then ceased to increase abouit exactly when Joeseph Biden was inaugurated. This is a much more relevant series than the nominal debt (do we focus on nominal anything else — at all ?). I was surprised to see this graph. Why ?
I think one thing is that it is not at all alarming – so very serious people don’t discuss it. Even more importantly, it shows that the US Federal Government can, in fact, inflate away its debts. THere are long term Treasuries owned by private investors. An increase in inflation causes an increase in nominal interest rates, that is a decrease in the market price of those treasury bonds notes and bills. This causes a capital loss for the investors (some of which were banks which then went bankrupt). It does not affect the debt (face value of the treasury securities) or interest paid on that debt (coupons fixed in dollars).
Expected inflation is neutral (it reduces the amoutn the Treasury gets when it auctions bonds so the real cost of borrowing for the Treasury remains the same. Unexpected inflation is windfall for the Treasury and a loss for those who bought expecting low inflation. This fact is unmentionable — even considering the possibility of inflating away debt is an unforgivable sin in the very serious village.
I guess another explanation is politics. It doesn’t do to say that sure the deficit is high but so is inflation so it’s OK. Both budget deficits and (especially) inflation are hated. Back in the 70s when I was a kid, I didn’t understand why people hated inflation or accepted a severe recession as a cure. I still don’t (effort to understand in another post).
Here is the annual change in the real debt (in 2023 Q2 dollars deflated with the GDP deflator)
Notice it is only negative under budget bills signed by Joe Biden or Bill Clinton.
The really important (and actually often discussed) variable is the ratio of the debt to GDP. This really determines sustainability — for the taxman it doesn’t matter whether GDP increases due to inflation or real GDP growth. However, the next amazing figure is not well known either (it is available on FRED without any work required)
Note it declined when CLinton was President and when Biden was president. The recent decline from over 134.83% to less than 120.65% is basically unprecedented. It is also almost entirely unmentioned. The fact that Treasuries can inflate away their debt is unmentionable. The drop is partly due to inflation — real GDP increased a lot from the Covid trough, but the percent increase in nominal GDP was, of course, dramatically greater.
clearly the main debt sustainability action is inflation (nominal/real) not the hugely important change in real GDP.
Now there is supposed to be a cost of inflating away debt with a surprising burst of inflation. The cost is it causes higher expected inflation which, if matched by actual inflation, provides no more help to the Treasury and is costly … for some reason which no one has ever explained to me. However, in the recent case, expected inflation remains low, so what’s the problem ? Of course investors lost (I think including me) but people who own a lot of treasuries can afford it. Some banks had to be rescued but it was not a huge problem.
So why do I hear about the deficit being a problem ?
