unsustainable public debts issues

  Unsustainable Public Debt As noted, persistent fiscal stimulus can result in a rising debt-to-GDP ratio and lead to an unsustainable level...

 

Unsustainable Public Debt As noted, persistent fiscal stimulus can result in a rising debt-to-GDP ratio and lead to an unsustainable level of public debt.20 A rising debt-to-GDP ratio can be problematic if the perceived or real risk of the government defaulting on that debt begins to rise. As the perceived risk of default begins to increase, investors will demand higher interest rates to compensate themselves. The tipping point at which public debt becomes unsustainable is difficult to predict. A continually rising debt-to-GDP ratio is likely to lead to an unsustainable level of debt over time. The threshold at which a nation’s debt becomes unsustainable depends on a number of factors, such as the denomination of the debt, political circumstances, and, potentially most importantly, underlying economic conditions. A change in these circumstances may shift a nation’s debt to be unsustainable without the underlying amount of debt changing at all. To date, it does not appear that the United States has an immediate concern with respect to unsustainability given that interest rates are historically low, 21 although the unpredictability of interest rates has led to some calls for caution. 22 The debt-to-GDP ratio in FY2020 was the highest since World War II and is projected to remain high, at least in the short-term, given the ongoing pandemic and recession.2

3 Decreased Business Investment Persistent fiscal stimulus, and the associated budget deficits, can decrease the size of the economy in the long term as a result of decreased investment in physical capital. 24 As discussed previously, the government’s deficit spending can result in higher interest rates, which generally lead to lower levels of business investment. Business investment—spending on physical capital such as factories, computers, software, and machines—is an important determinant of the long-term size of the economy. Physical capital investment allows businesses to produce more goods and services with the same amount of labor and raw materials. As such, government deficits that lead to lower levels of business investment can result in lower quantities of physical capital and therefore may reduce the productive capacity of the economy in the long term.

25 As discussed earlier, some of the increase in interest rates and decline in domestic investment resulting from fiscal stimulus could be offset by additional capital flowing into the United States 19 Manmohan S. Kumar and Jaejoon Woo, Public Debt and Growth, International Monetary Fund, Working Paper, vol. 10, no. 174 (July 2010). 20 Public debt is the money that the government owes to its creditors, which include private citizens, institutions, foreign governments, and other parts of the federal government. For more information on the public debt, see CRS Report R44383, Deficits, Debt, and the Economy: An Introduction, by Grant A. Driessen. 21 Olivier Blanchard, Reexamining the Economic Costs of Debt, Peterson Institute for International Economics, November 20, 2019, https://www.piie.com/commentary/testimonies/reexamining-economic-costs-debt. 22 John Cochrane, “Debt Denial,” The Grumpy Economist, December 9, 2020, https://johnhcochrane.blogspot.com/ 2020/12/debt-denial.html. 23 U.S. Congressional Budget Office (CBO), Monthly Budget Review: Summary for Fiscal Year 2020, November 9, 2020, p.

 1. 24 Depending on the size of the capital stock and the debt-to-GDP level, particularly when both are initially relatively low, deficit-financed government investment, such as infrastructure projects, may lead to a higher capital stock overall and therefore increase the productive capacity of the economy. 25 Ball and Mankiw, “What Do Budget Deficits Do?” Fiscal Policy: Economic Effects Congressional Research Service 7 from abroad. The inflow of capital from abroad can be beneficial if it allows for additional investment in the U.S. economy. However, in exchange for these capital flows, the United States would be sending a portion of its national income to foreigners in the form of interest payments. With a larger portion of the capital stock owned by foreigners, rather than Americans, a larger portion of the U.S. national income would be sent abroad. Crowding Out Government Spending Rising public debt may also be of concern due to its associated interest payments. All else equal, an increase in the level of public debt will result in an increase in interest payments that the government must make each year. Rising interest payments may displace government spending on more worthwhile programs. In 2019, interest payments on the debt were $375 billion. Despite a roughly 25% increase in the amount of debt held by the public in FY2020,26 interest payments are down 8.5% from 2019, at $337 billion, due in large part to lower interest rates. 27