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Has John Taylor Forgotten About Compound Interest?

By Matthew Yglesias  

"Has John Taylor Forgotten About Compound Interest?"

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I wouldn’t expect right-of-center economists to be enthusiastic about Barack Obama’s economic agenda, which obviously reflects a left-of-center belief that high levels of government services are more important to future prosperity than are low tax rates. But hostility to the Obama agenda seems to me to have caused a remarkable number of right-of-center economists to start making bizarre analytic errors. For example, John Taylor is a Professor of Economics and Stanford and a fellow at the Hoover Institution. I’m sure he knows more economics than I do. So how did he come to write this in the Financial Times?

To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years.

That’s not right at all. Somehow Taylor’s managed to forget facts about compound interest that I was taught in ninth grade. At 10 percent inflation, the price level doubles in seven years. Alternatively, seven percent inflation will cause the price level to double in 10 years:

prices

This doesn’t, I suppose, vitiate the point that a big run-up in the debt-to-GDP level could spell trouble. But it’s a pretty remarkable error to slip into a prominent newspaper by a prominent economist.

Meanwhile, Felix Salmon observes other errors in the column and Mark Thoma observes that until very recently Taylor thought we should stimulate the economy with permanent tax cuts that would have made this situation worse.

Update

I see that Professor Taylor was also enthusiastic about John McCain’s tax agenda, which would have produced even worse deficits than those currently projected.

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