Conventional economics has a tough time explaining why there’s not a straight-line relationship between more debt and more growth. If, however, one thinks of debt as being subject to diminishing returns, which it most certainly is, then its return, in terms of growth, will decrease as more debt is added. Eventually, debt service can overwhelm benefits completely, in which case debt actually subtracts from growth. See the Debtonomics Archive. From MN Gordon at acting-man.com:
Onward vs. Upward
Something both unwanted and unexpected has tormented western economies in the 21st century. Gross domestic product (GDP) has moderated onward while government debt has spiked upward. Orthodox economists continue to be flummoxed by what has transpired.
What happened to the miracle? The Keynesian wet dream of an unfettered fiat debt money system has been realized, and debt has been duly expanded at every opportunity. Although the fat lady has so far only cleared her throat (if quite audibly, in 2008) and hasn’t really sung yet, it is already clear that calling this system careening toward a catastrophic failure.
Here is the United States, since the turn of the new millennium (starting January 1, 2001) real GDP has increased from roughly $10.5 trillion to $18.6 trillion, or 77 percent. Over this same time government debt has spiked nearly 250 percent from about $5.7 trillion to $19.9 trillion. Obviously, some sort of reckoning’s in order to bring the books back into balance.
Throughout this extended episode of economic and financial discontinuity, the government’s solution to jump-starting the economy has been to borrow money and spend it. Thus far, these efforts have succeeded in digging a massive hole that the economy will somehow have to climb out of. We’re doubtful such a feat will ever be attained.
In short, additions of government debt over this time have been at a diminishing return. Specifically, at the start of the new millennium the debt to GDP ratio was about 54 percent. Today, it’s well over 100 percent.
US GDP and US federal debt, indexed (1984 = 100). Mises noted back in the late 1940s already that “it is obvious that sooner or later all these debts will be liquidated in some way or other, but certainly not by payment of interest and principal according to the terms of the contract.” If it was obvious then, it is glaringly obvious today. Greece and Cyprus demonstrated what happens when modern socialist welfare states have no independent access to a printing press and are thus unable to extend and pretend in the traditional Keynesian way. The Potemkin village disintegrates on the spot at the first whiff of suspicion. All the nations that have postponed the reckoning by printing money and the flight forward mechanism of amassing even more debt have simply made the eventual denouement more profound.
To continue reading: The Long Run Economics of Debt Based Stimulus