In the past decade, the amount of public debt of the United States has grown substantially. Based on the statistics released by Federal Reserve Bank of St. Louis, the total public debt as a percentage of Gross Domestic Product (GDP) has grown from 64.3 percent in 2008 to 104.8 percent in 2016. As of today, the total national debt is near $20 trillion. About 73 percent of this debt is held by the public. The graph below demonstrates the growth path of public debt to GDP over the years.

Figure 1. Federal Debt Held by the Public as Percent of GDP

Theoretically speaking, a debt crisis can lead to a decrease in economic growth, since there is a tendency that public start to suspect the possibility of government default on the debt, which would largely decrease the purchasing power. Also, the fast growing of the public sector could eventually create crowing out effect, which impose an adverse effect to the economy. Consider the case of Venezuela, based on World Bank’s report, Venezuela was largely affect by the collapse in international oil prices, which leads to a serious financial crisis. Due to the limitations on external financing, a large amount of debt was monetized. This monetization led to a very high inflation rate of 68 percent, higher than the rest of the world. So the question to ask now is that can the United States bear the burden of $20 trillion of debt? Can the strong US economy be able to pay back this debt?

Before addressing such questions, it is important to note that whether infinite debt roller exists, and if it does, what are the constraints. In the article Can the Government Roll Over Its Debt Forever? by Andrew B. Abel, he stated that a sustainable debt path is possible only when the interest rate is less than or equal to the growth rate of GNP. Abel used GNP as a measure of national income, yet GDP is more favorable nowadays. As stated above, when the debt-GDP ratio gets extremely large, such that the interest payment of debt is the same as or even larger than the country’s GDP, the government would not be able to repay the debt. Obviously, the United States is still far away from this extreme stage, yet the rapidly increasing of its national debt and the increasing trend of interest rate is causing some concerns. Congressional Budget Office (CBO) recently published the Budget and Economic Outlook: 2017 to 2027. CBO projects that over the next decade, under the current law, the large increase in government spending on retirement and health care programs and increase in interest payments on the government debt with modest growth in revenue would lead to a rising in budget deficit. This growing deficit is projected to further increase the debt held by the public, rising from 77 percent at the end of 2017 to 89 percent by 2027. CBO also projects that the US’s economic growth will remain modest for at least of the next two years, at an average annual growth rate of 2.1 percent. The federal funds rate is expected to gradually increase, reaching 3.1 percent in the next decade. This rate is the baseline, and it is hard to accurately estimate the future interest rate. CBO estimates that if actual interest rate is 1 percent higher than the baseline, while keeping other economic variables unchanged, the cumulative deficit for the next decade would be $1.6 trillion higher. Overall, the take away from this outlook is that the high public debt is rising some serious concerns of the economy,

In conclusion, the United States is on an unsustainable debt path, and government action is needed to direct the debt back to its correct path. This can be achieved by several ways, that the federal reserve can either monetized or default the debt. By doing this, however, will create hyperinflation which consequently shrinks the wealth of the retirees, people who mostly rely on fixed income. Cutting government spending or increasing taxes are also ways to decrease the debt, yet such contractionary fiscal policies will hurt the country’s total output thus leads to an even lower GDP growth. If the government choose to let the debt accumulate in the future, it could potentially cause public distrust which implies unstable economy. In addition, with a high risk of default, creditors will demand a higher interest rate to compensate the risk. This intensifies the burden of the government, and accelerate the growth of debt-GDP ratio. While it is possible that in the future, the renovation of political regime could result a large positive fiscal shock to the economy that solves the issue, it is hard to give suggestions on the reformation of the policy and predict effect of such policy. The solution is still up in the air, but one thing for certain is that the government should start acting before it is too late.

 

 

 

 

Is the United States On a Sustainable Debt Path?