Monday, April 18, 2011

What Does "As a share of GDP" Mean?

From the top story at at this hour, dealing with Standard & Poor's lowered outlook for U.S. sovereign debt:

"Both political parties now agree that it is time to begin bringing down deficits as a share of GDP," Mary Miller, assistant secretary for financial markets at the Treasury Department, said in a written statement. "We believe S&P's negative outlook underestimates the ability of America's leaders to come together to address the difficult fiscal challenges facing the nation."
" a share of GDP..." What does that mean to you? Let's convert the numbers (presently in the trillions) to ones we more commonly understand. Suppose the "gross domestic product" of your household—for this example, all of the income generated by all the people in the household—is $50,000 in the year 2011. Because you spend like the government, you have spent $60,000 and generated $10,000 debt this year, which is 20% of your household GDP. [This would be in addition to the many years of debt you've been racking up prior to 2011.] As the leaders of your household come together for a meeting, they all agree that annual debt consisting of 20% of household GDP—up from, say, 12% in previous years—is pretty high, and that something needs to be done about it. After all, it's getting harder to make all the credit card, car, vacation home, jet ski, timeshare, home alarm system, and charity payments to lazy neighbors simultaneously.

So here's what one of them says:

We need to rein in our debt by keeping it at the level of 20% of household GDP.
And the rest of them? They all should look at the speaker and, as politely as possible, point out how stupid that is and how utterly ineffective it is in dealing with the problem...and once the speaker understands that, they should point out that in the long-term, this will only make the problem worse.

What the speaker is implying is this: That if next year's household income rises to $60,000—a very optimistic forecast in the current economy—it will be OK to incur $12,000 (that's 20% of $60,000) more in debt, to add to all those prior years' worth of debt. For that matter, even if one of these people should recommend that the debt be limited to 12% of household GDP, it's still a bad idea; the way to get rid of debt is to reduce spending to below the level of income!

And this the federal government does not yet seem to understand. Our leaders in Washington DC need to determine what needs to be done, as soon as possible, to get the level of government spending to less than the level of government income.

If they want suggestions, I will be happy to offer them.

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