Tuesday, November 11, 2008

Stimulus, Debt and US Debt Ratings

From Paul Krugman:

So we need a fiscal stimulus big enough to close a 7% output gap. Remember, if the stimulus is too big, it does much less harm than if it’s too small. What’s the multiplier? Better, we hope, than on the early-2008 package. But you’d be hard pressed to argue for an overall multiplier as high as 2.

When I put all this together, I conclude that the stimulus package should be at least 4% of GDP, or $600 billion.

From CNBC:

The United States may be on course to lose its 'AAA' rating due to the large amount of debt it has accumulated, according to Martin Hennecke, senior manager of private clients at Tyche.

"The U.S. might really have to look at a default on the bankruptcy reorganization of the present financial system" and the bankruptcy of the government is not out of the realm of possibility, Hennecke said.

This is only one man's opinion so it's obviously open to debate.

Let's look at this from a debt/GDP perspective. Right now total US debt is about $10.5 trillion while total GDP is about $14.4 trillion (or so). That makes debt/GDP roughly 72%. With the economy contracting the $14.4 trillion will remain the same. So let's increase total US debt to $11.5 trillion. That brings debt/GDP to roughly 80%. While I don't think that means loss of the AAA rating, I do think it puts upward pressure on rates making all that debt far more uncomfortable for policy makers.