Did the U.S. Really Grow Out of Its World War II Debt?

IMF Working Papers, January 12, 2024

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The U.S. public debt/GDP ratio fell from 106% in 1946 to 23% in 1974 in actual history.
The paper examines three factors that contributed to that decline in addition to high rates of economic growth:
- primary budget surpluses,
- surprise inflation,
- pegged interest rates before the Fed-Treasury Accord of 1951.
Central simulation result (counterfactual): with primary budget balance and without the distortions in real interest rates caused by surprise inflation and the pre-Accord peg, debt/GDP declines only to 74% in 1974, not 23% as in actual history.
In that counterfactual, the debt/GDP ratio starts rising again in 1980 and in 2022 it is 84%.
Interpretation: over the last 76 years, only a small amount of debt reduction has been achieved through growth rates that exceed undistorted interest rates.

Construction of a counterfactual simulation of the path of the debt/GDP ratio that:
- imposes a primary budget balance,
- removes distortions in real interest rates arising from surprise inflation and the pre-Accord peg.
Comparison between actual history and the counterfactual highlights the quantitative importance of non-growth factors (fiscal surpluses, surprise inflation, financial repression via pegged rates) in reducing the public debt/GDP ratio after World War II.

Large observed post-war decline in debt/GDP cannot be attributed primarily to growth exceeding undistorted interest rates.
Surprise inflation and pegged nominal interest rates (financial repression) played major roles in reducing real debt burdens.
Achieving similar debt reductions today would likely require policies affecting primary balances, inflation expectations, or nominal interest-setting regimes rather than relying on growth alone.