Please note that we are discussing the debt-to-GDP ratio, not just the debt level. Deficits, which result in more debt, increase the numerator of this ratio. However, both inflation and economic growth increase the denominator, reducing the ratio assuming other factors remain constant. By using algebraic equations, we can express debt dynamics as follows:
Change in debt/GDP = primary deficit/GDP + (r-g)*(debt/GDP)
The primary deficit refers to the budget deficit excluding interest payments. “r” represents the interest rate on government debt, while “g” denotes the economy’s growth rate. If “r” significantly surpasses “g,” a debt spiral may occur. In such a scenario, rising debt leads to an accelerated accumulation of debt.
However, a few years ago, Olivier Blanchard, a highly respected macroeconomist, presented a presidential address to the American Economic Association. His address demonstrated that historically, “r” has generally been lower than “g.” Therefore, a debt spiral is unlikely.
Have the recent increases in interest rates altered this conclusion? Not significantly. Even after the rate surge in the past few days, the interest rate on inflation-protected 10-year U.S. bonds stood at 1.83 percent. This rate is close to most estimates of the economy’s sustainable growth rate. Even by taking the lower end of these estimates, the possibility of a debt spiral remains remote, albeit very slow-moving. To illustrate, with “r” at 1.8 and “g” at 1.6, stabilizing the debt ratio at 100 percent of GDP would necessitate a primary surplus of 2 percent of GDP. Increasing the debt to 150 percent would only require that surplus to rise to 3 percent.
Therefore, while we may face the potential for significant future increases in debt, interest payments on existing debt are not the primary culprit. Instead, the issue lies with these primary deficits.
Consequently, the problem is fundamentally political. As mentioned earlier, it is advisable to disregard individuals who emphasize TRILLIONS OF DOLLARS or criticize wasteful government spending. The federal government essentially functions as an insurance company with an army, primarily spending on public demands such as the military, Social Security, and health programs. However, we encounter an effective opposing coalition against raising taxes sufficiently to fund these programs. As a result, we will continue accumulating debt until this impasse is resolved.
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