Thursday, September 18, 2008

Can the US afford the bail outs?

Writing in the FT, Harvard Prof Kenneth Rogoff estimates that the US government will end up coughing up close to a trillion dollars in bail-outs for its trouble financial sector. Upto now, the cost is around $200-300 bn. Can the US afford this kind of cost? Rogoff thinks it is very steep and will impose costs in terms of higher interest rates, inflation and lower growth.

We should be careful not to get carried away. A trillion dollars is under 8% of US GDP. That is big but still falls in the lower end of bank recapitalisation costs consequent to economic crises- the range is 5-45% of GDP.

US public debt, at $ 4.4 trillion, is 32% of GDP, pretty much on the low side considering that the limit for EU economies under the Maastricht Treaty is 60% of GDP (India has over 70% of GDP in debt). That means there is room for another $4 trillion of US debt. So, even if the bail-outs were to amount to $1 trillion, the US and the world economy can take that cost in their stride.


nari said...

Hi i came acros your blog details on pagal guy. Could you tell me what is public debt all about ? What is the significance of that ? Let me introduce my self sir ..i am naresh polisetti working for capgemini ( hyderabad ).

Anonymous said...

Sir, I agree with your view that the Trillion dollar cost at the present time is something the US economy can take in its stride, assuming the clean up effort is done right. However, you are ignoring two important facts: looming fiscal deficits due to upcoming demographic changes, and massive current account deficits. This makes it non-trivial. I agree that the US will make it through this crisis, but it cannot continue down this path recklessly. I think we will enter a period of more regulation and slower growth.