An article today by Paul Krugman, the Nobel Prize winning economist, titled ‘How big is $9 trillion?’ says:  “There’s been some hysteria about the administration’s new estimate that the cumulative deficit will be $9 trillion over the next decade. Don’t get me wrong: this is bad. But it’s being treated as an inconceivable sum, far beyond anything that could possibly be handled. And it isn’t”.  Dr. Krugman goes on to say that the U.S. economy and federal tax base is also enormous, that GDP currently is about $14 trillion, and that economic growth averages 2.5% a year (which he says has ‘been the norm’) and inflation is the targeted 2% a year GDP will be around $22 trillion a decade from now (the calculation actually results in $21.74 trillion.  I made the calculation to be sure the 2.5% was indeed a ‘real growth’ factor) – which Dr. Krugman says would result in adding debt equal to about 40% of GDP in circumstances where federal debt is about 50% of GDP.  He goes on to say that “So even if we do run these deficits, federal debt as a share of GDP will be substantially less than it was at the end of World War II. It will also be substantially less than, say, debt in several European countries in the mid to late 1990s. He concludes by saying “Again, the debt outlook is bad. But we’re not looking at something inconceivable, impossible to deal with; we’re looking at debt levels that a number of advanced countries, the US included, have had in the past, and dealt with”.  My comments are:

•    first, Dr. Krugman’s starting point of accepting the Administration’s ‘new estimate’ of a cumulative deficit of $9 trillion over the next 10 years may prove to be understated given what I think to be the importance (in particular) of the loss of manufacturing jobs in the U.S. over that past decade;

•    second, I am very skeptical of Dr. Krugman’s assumption of 4.5% nominal GDP growth per year compounded over the next 10 years based on underlying 2.5% real growth and a 2.0% inflation rate.  I could better understand it if it were based on a lower growth rate and a higher inflation rate.  In order to accept such numbers I need to know where specifically Dr. Krugman believes 2.5% compounded real growth is going to come from in an economy that continues to lose jobs in general and manufacturing jobs in particular, and specifically why he thinks it appropriate to assume a compounded inflation rate over the next 10 years of 2% – in my view a very long time period to predict anything, particularly in the uncertain economic times we currently are experiencing;

•    third, I think compounding from today on a straight line basis for 10 years is very risky (see my other post today commenting on Roubini’s view of a possible ‘double dip’ recession).  If the growth Dr. Krugman is assuming in his calculations doesn’t happen beginning immediately, the compounding result in the later years of the 10 year period is (arithmetically) significantly reduced.

I for one don’t take much comfort from Dr. Krugman’s article, and I encourage readers to ‘Think for Themselves’ – my increasingly consistent stated mantra.

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