The ruckus in the United States over the federal debt ceiling has redirected attention toward soaring public borrowing. Against the backdrop of monetary tightening by the Federal Reserve, piling up more debt is reinforcing concern about the explosive growth of the government’s interest obligations.
It’s a terrifying narrative, redolent of impending crisis. The only problem is that virtually every element of it is wrong.
First, government debt is not soaring. The Congressional Budget Office forecasts that debt held by the public will rise from a bit less than 100% of GDP in 2022 to slightly more than 110% in 2033. While worth watching, this increase is by no means catastrophic. And while the CBO sees the debt ratio, fueled by entitlement spending, rising more quickly after that, there are more pressing problems to attend to today than what happens after 2033. Urgent needs include renewing US infrastructure, averting a climate disaster, and providing education and training for the young. Cutting essential public programs now to address a debt problem that won’t even begin to materialize for a decade would be shooting ourselves in the foot.
Second, interest costs are not exploding. To be sure, inflation remains elevated, which pushes up short-term interest rates. But, because the US Treasury issues long-term bonds, debt-servicing costs depend on long-term rates, which have risen by less.
Currently, the interest rate on ten-year government bonds is 3.6%, while the CBO’s inflation forecast for that horizon is 2.4%, so the real (inflation-adjusted) interest rate relevant for calculating the interest burden is still only 1.2%. And as the former IMF chief economist Olivier Blanchard reminds us in an important new book, what matters is the difference between the real interest rate and the growth rate of the economy. If the real interest rate is lower than the growth rate of inflation-adjusted GDP, then the debt ratio can fall even when the government runs budget deficits. The CBO’s forecast for growth over the next ten years is 1.7% – higher than the real interest rate.
This is not a licence to engage in unlimited spending. But it implies that, given a debt-to-GDP ratio of 100%, the federal government can run deficits of 0.5% of GDP (the difference between 1.7% and 1.2%) over and above its interest payments without causing the debt ratio to rise.
It is conceivable that the CBO is overestimating the US economy’s growth potential. Productivity growth has been trending downward, and that downward trend could persist. Equally, however, the CBO could be underestimating potential growth, given that firms are only beginning to exploit the new technologies springing up all around us. A prudent way to proceed is to adopt the CBO’s estimate while acknowledging the considerable uncertainty surrounding it. Inflation will come down, given the Fed’s commitment to reducing it.
So, too, will nominal interest rates, given investors’ awareness of the Fed’s commitment.
Which comes down faster – what happens to the real interest rate, in other words – will depend on the balance of saving and investment. Think of it this way: the more savings are available to fund productive investment projects, the lower will be real rates of return. On the savings side, the past is a good guide to the future, because the factors determining the savings available to the US economy evolve slowly over time. Principal among them are the average age and longevity of the population. Insofar as longevity dominates, and people anticipating more years in retirement save more, the supply of savings and demand for US Treasury bonds are both likely to rise. Working in the other direction is the supply of saving from China and other emerging markets, what former Fed Chair Ben Bernanke called the “global savings glut.” With growth in China slowing, this source of saving will decline.
Moreover, the willingness of China and other emerging markets to invest specifically in US Treasury bonds will diminish, given the rise of US-China tensions and the US government’s demonstrable willingness to impose financial sanctions on governments whose policies it doesn’t like. A good guess is that these different changes in savings supply, working in opposite directions, will be more or less offsetting. The important action, then, will be on the investment side.
There will be political pressure and considerable economic incentive for additional investment in infrastructure, climate-change abatement, health-care delivery, and new digital technologies. Competition for a limited supply of savings by those undertaking these additional investments will put upward pressure on interest rates, making debt sustainability more tenuous. But those same investments, if carried out intelligently, will boost economic growth, making debt sustainability less of a problem. Those who imagine an imminent debt crisis are making much ado about nothing. It would be better if US policymakers saved their energy – and political capital – for fighting real rather than imaginary battles. Copyright: Project Syndicate, 2023
Barry Eichengreen, Professor of Economics at the University of California, Berkeley, is a former senior policy adviser at the International Monetary Fund. He is the author of many books, including In Defense of Public Debt (Oxford University Press, 2021).