Exploding U.S. Debt Is a Problem, Not an Emergency

Tick, tick, tick Bloomberg News | James Alexander Michie

Tick, tick, tick. Photographer: Steve Pope/Getty Images

Don’t cut badly needed coronavirus spending now. (But pare Social Security and Medicare later.)

Government programs to blunt the economic impact of the coronavirus pandemic will make the federal budget deficit much wider in 2020 than at any point in the last 75 years. The nonpartisan Congressional Budget Office’s new forecasts, released this week, predict that the deficit will be over $3.3 trillion this year, or 16% of annual economic output. Measured as a share of GDP, the annual U.S. budget deficit hasn’t hit double digits since 1945. The CBO forecasts that the 2021 deficit will be higher than in all but two years between 1946 and 2019.

These deficits will boost the national debt, which the CBO forecasts will total $21.9 trillion in 2021. Next year, for the first time since World War II, the national debt will be larger than annual GDP. Beginning in 2023, the CBO projects that the debt will be larger than at any point in U.S. history.

That’s a problem, but not a reason to panic. Now isn’t the time to reduce the debt, but the bill will eventually have to be paid.

Debt and deficits matter. Some on the political left argue that they don’t, embracing “modern monetary theory” as a permission structure for significant increases in federal spending on the unpersuasive grounds that the federal government can print all the money it needs. Some on the political right argue that deficits matter more than they actually do. It was common to hear conservatives warn that the U.S. was on the brink of a Greek-style debt crisis as a consequence of the borrowing following the 2008 financial crisis and recession. Many Republican senators today oppose an additional economic recovery package because they are excessively concerned about borrowing.

The truth about deficits and debt is in-between. The economic damage they cause is more akin to slow rot in the foundation of a house than a tornado suddenly blowing it down.

Deficits reduce national savings, shrinking the pool of funds available for private-sector investment. Over time, less investment leads to lower productivity and slower wage growth, reducing living standards and economic output. Inflows of foreign capital can make up for this, but also lead to increases in payments to foreign investors and reductions in domestic income. In a 2014 paper, the CBO estimated that a one-dollar increase in the budget deficit reduces national savings by 57 cents and domestic investment by 33 cents. Additional debt increases interest rates. A 2019 CBO working paper found that a one-percentage-point increase in the ratio of debt to annual GDP increases rates by two to three basis points.

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Source: Michael R. Strain | Bloomberg

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