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Does Government Debt Matter Anymore?


Published December 7, 2021

Proponents of government spending argue that the government can borrow as much as it wants, so long as the interest rate is less than the rate of economic growth. However, government deficits are far too high for this to be the case. Continuing to run large deficits will either lead to higher inflation or sharp cuts to entitlement programs. Solving the US fiscal problem will require strong pro-growth policies, a slowdown in government spending, and reforms to our chaotic tax system and entitlement programs.

Discussion Questions:

  1. How does America’s current fiscal situation differ from previous periods of high debt?
  2. What changes can America make to its tax system and entitlement programs to solve its fiscal problem?

Additional Resources:

  • Read “r < g,” by John Cochrane. Available here (PDF).
  • Watch the Hoover Institution Policy Seminar with John Cochrane. Available here.
  • See if you can solve the US debt crisis with the “America Off Balance” Budget Calculator. Available here.
View Transcript

The federal government is borrowing money at an astonishing rate. However, the interest rate is lower than the rate of economic growth. If that lasts, it is possible that the government can just roll over its debt, borrowing new money to pay interest. Debt will grow forever, but the economy will grow faster, so debt will fall relative to the size of the economy.

Proponents of government spending cite this possibility as a justification for borrowing even more, mostly to send money to people and businesses.  And borrowing money, sending it to people, and never raising taxes to repay it is catnip to a politician’s ears:  If the government doesn’t have to pay back debts, why should any citizens have to pay back our debts? Borrow and bail us out! Why should we work?

Will it work? Or will big borrowing have to be followed by big taxes and big spending cuts, if we are to avoid big inflation, or worse, a really big debt crisis?

The interest vs. growth rate question is a fascinating technical debate for economic theorists. But we don’t have to fight it, as the story simply does not apply to the actual US fiscal situation.

The US is running regular primary deficits of 5% of GDP; and an extra 20% in each crisis. Then, in a few years, Social Security and medical spending really explode the deficit. Yes, if the interest rate is one percentage point less than the growth rate, and with debt at 100% of GDP, the US can run deficits of one percent of GDP, but not five or ten percent. Finding pennies in your couch will not buy a new car.

Growing out of debt requires that taxes equal spending for a generation or two while growth outpaces interest. But taxes equal to spending for decades would be a debt hawk’s dream come true! The US situation is an intractable exploding debt-to-GDP ratio, and steady large deficits, not a slowly declining ratio with balanced budgets, that we might bump to a higher level with a “one-time” expansion.

Strong growth and low interest rates did help the US to reduce debt relative to GDP following World War II. But the war and its spending were over, and the US also ran steady primary surpluses for two decades, not our steady deficits. And the experience was not painless. We had two big bouts of inflation, and a major crisis in the early 1970s, which effectively wiped out a lot of debt. There was a lot of financial repression – you couldn’t buy stocks abroad, or even change much currency. And the US experienced four percent and more growth, more than ever seen before in history, in a much more dynamic and less regulated economy, not the anemic two percent growth facing us now.

One might say, well, ride the low-interest rate bubble while it’s here, and fix it later if debt seems to cause trouble. But debt problems do not resolve quietly and predictably. Too much debt results in either sharp inflation, crushing taxes and sharp deep benefit cuts, or a chaotic debt crisis, which would be a financial catastrophe. The end comes quickly and unexpectedly. Markets smell a crisis coming, so they charge higher interest rates. Higher interest rates worsen the deficit. That makes the crisis arrive faster. And unlike Greece and Italy, there is no Germany to bail out the US.

Solving the US fiscal problem is not that difficult. Simple reforms of our chaotic tax system can produce more revenue with less economic damage. Simple reforms of our entitlements can direct money to people who need it much more effectively. Strong pro-growth policies would produce much more revenue and less spending. And most of all, Congress and the Administration must stop spending as if money can be printed or borrowed with no consequence, and return to spending money as if taxpayers actually have to pay for it, now or later. Because they do.