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This paper examines the effects of primary budget surpluses, surprise
inflation, and pegged interest rates before the Fed-Treasury
Accord of 1951 on the U.S. public debt/GDP ratio. We find that
with primary budget balance and without the distortions in real
interest rates caused by surprise inflation and the pre-Accord peg,
debt/GDP would have declined only from 106% in 1946 to 74% in
1974, not to 23% as in actual history. Our findings imply that,
over the last 76 years, only a small amount of debt reduction has
been achieved through growth rates that exceed undistorted interest
rates.
