Debt Ceiling

The Morning After America's Debt Binge

The hangover will likely last two decades

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Obama with beer
Frugal Cafe

President Barack Obama is adamant that he will not be held "hostage" by the Republicans in the House of Representatives, who are threatening not to raise the U.S. debt ceiling without some concessions on future spending and Obamacare. If the debt limit is not raised, allowing the Treasury Department to borrow more money, the federal government will default on some of the bills it owes in the next couple of weeks. Lots of commentators believe that such a default would have significant, if not devastating, downside economic effects.

Maybe so. But we should also want to consider the ways a relentlessly rising level of debt could damage our economic prospects. The debt ceiling for the United States is currently set at $16.7 trillion. In 2000, the U.S. national debt stood at $5.7 trillion. The amount of the U.S. national debt is now roughly the same size as the annual output of the economy. Is this a problem?

Yes, suggests recent research by numerous macroeconomists. Specifically, they find that a big public debt "overhang" likely slows down future economic growth for more than two decades. In other words, excessive national debt racked up now will make future Americans considerably poorer than they would have been otherwise.

Let's start with a 2012 study in the Journal of Economic Perspectives, conducted by the Harvard economists Carmen Reinhart and Kenneth Rogoff and Morgan Stanley chief economist Vincent Reinhart. In that study, which looked at 22 advanced countries, the researchers identify in the years between 1800 and 2011 some 26 episodes lasting more than five years in which public debt to GDP ratios exceeded 90 percent. They argued that if the public debt-to-GDP ratio is greater than 90 percent for five or more years, then, on average, economic growth rates fall from an average of 3.5 percent to 2.3 percent annually, a drop of 1.2 percent. Even the fierce critics who pointed out a major error in the earlier work of Rogoff and Reinhart find that when the debt-to-GDP ratio is greater than 90 percent that subsequent economic growth averages 2.2 percent annually, falling from 4.2 percent when the ratio is below 30 percent.

Similarly, a 2010 working paper by the International Monetary Fund economists Manmohan Kumar and Jaejoon Woo looked at the effect that high public-debt-to-GDP ratios had on the economic growth of 38 advanced and emerging economies between 1970 and 2007. The study found evidence that surpassing a debt-to-GDP threshold of 90 percent has a significant negative effect on growth. The researchers also reported that a 10 percent increase in the debt-to-GDP ratio is associated with a 0.2 percent slowdown in annual real per capita GDP growth. As it happens, America's debt-to-GDP ratio climbed from around 60 percent in 2003 to a projected 108 percent this year. If the IMF's findings are accurate, that implies that future economic growth rates will be about one percent lower than they would otherwise have been. Kumar and Woo concluded that the chief cause for depressed economic growth is less investment in capital goods, which in turn produces a slowdown in labor productivity.

A 2011 Bank for International Settlements working paper, drawing on data on government debt in 18 economically developed countries from 1980 to 2010, found that passing a debt-to-GDP threshold of 85 percent slowed growth. Specifically, the study found that a 10 percent increase in the debt-to-GDP ratio resulted in a nearly 0.2 percent reduction in subsequent average annual growth. "The immediate implication is that countries with high debt must act quickly and decisively to address their fiscal problems," the researchers concluded. "The longer-term lesson is that, to build the fiscal buffer required to address extraordinary events, governments should keep debt well below the estimated thresholds."

In a 2012 article in the Journal of Accounting and Finance, economists from the University of Dallas and Hofstra University assessed the maximum sustainable level of national debt for the United States. Assuming that the economy was operating at its full potential, the researchers estimated the sustainable upper limit of the debt-to-GDP ratio is around 93 percent. "A higher debt to GDP ratio is unsustainable and will drive the economy into a succession of lower growth periods accompanied by increased unemployment," they concluded.

Rogoff and colleagues acknowledge that the 90 percent ratio "should not be taken as a law of nature." Nevertheless, most recent research on the effects of a sustained debt-to-GDP ratio higher than 90 percent has converged on the finding that it reduces future economic growth by more than one percent from what it would have otherwise have been. A one percent cut in economic growth may not sound like much, but over time it means that Americans in the coming decades will be a lot poorer than they would have been. Rogoff and colleagues estimated that effects of such a public debt overhang last about 23 years. 

Before the financial crisis, U.S. economic growth averaged 3.2 percent annually. If a high debt-to-GDP ratio reduces growth by one percent each year, future annual growth will likely average 2.2 percent. With a population of 315 million, the U.S. currently has a GDP per capita of roughly $53,000. The Census Bureau expects U.S. population to grow to about 375 million over the next two decades. In 20 years, the difference between economic growth of 3.2 versus 2.2 percent amounts to $5.5 trillion. At an annual economic growth rate of 3.2 percent, per capita income would rise to $84,000 over the next 20 years. On the other hand, growth at 2.2 percent would yield a per capita income of $72,000.

In other words, Americans two decades hence would be, on average, $12,000 poorer than they would have been had our leaders the foresight to rein in our burgeoning levels of public debt.

Such a long-term economic slowdown does not have the fiscal drama that the White House and Congress are using to entertain the rest of us. Yet, as Rogoff and company comment, the "debt-without-drama" scenario is reminiscent of T.S. Eliot's famous lines: "This is the way the world ends/Not with a bang but a whimper." When then-Senator Barack Obama opposed raising the debt ceiling back in 2006, he warned, "Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren." He added, "America has a debt problem and a failure of leadership. Americans deserve better." We still do.

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30 responses to “The Morning After America's Debt Binge

  1. Better alt-text: “See, if I can give a urine sample, so can every American. Leaking I can believe in!”

  2. Debt ceiling not being raised =/= default. If the fed govt chooses to make their top priority servicing the debt payments, then no default. It’s a matter of what they decide to spend the trillions they do rake in on.

    I’m all for default, BTW — they would force future govt to live strictly within their tax take.

  3. Strictly, the problem isn’t the government “not paying it’s bills” but actually defaulting on its debts. Delaying payment for goods and services has some problems, but it wouldn’t constitute an “event of default”. And that latter one is the sword of Damocles. When that happens, international capital markets risk running for safety and repo markets risk seizing up on uncertainty about collateral arrangements.

    The weird thing here is that what’s being reported in the news is almost the exact opposite of what is really happening. While I can’t say I’m a particular fan of the Republicans, they’ve urged the prioritization of interest payments over other spending. This would largely defuse the possibility of an actual default event, as revenues are basically sufficient to pay interest for an extended period of time. The administration has refused that. To make matters worse, Sen. Reid has declared that he won’t negotiate on the debt ceiling until the government is re-opened, mandating the passage of a continuing resolution. Of course, he’s said he won’t sign off on any “dirty” continuing resolution. So the Democratic position has come down to “give us everything we want, or we’ll drive the country into default”. Yet, somehow, it’s the Republicans who are the hostage takers.

    1. The weird thing here is that what’s being reported in the news is almost the exact opposite of what is really happening.

      And by “weird”, of course you mean Business As Usual.

      1. Sort of. But, this goes beyond anything I’ve ever seen. Sure, they usually throw in a ton of BS to support their version of the narrative. But, I don’t think I’ve ever seen it 180 degrees opposite of reality. It’s not a zero correlation. It’s a negative one correlation.

  4. If the debt ceiling is $16.7 trillion and the debt is $5.7 trillion, why do we need to raise the debt ceiling? Either the numbers are wrong or I’m not clear on the definitions.

    1. In 2000, the U.S. national debt stood at $5.7 trillion.

      1. And in 2000, the projections were the publicly held debt would all be paid off and there would be zero US Treasuries outstanding anywhere.

        But from 2001 to 2006, Bush and the Republican Congress worked hard to cut taxes to pay for several trillion in new spending on two wars and all the decades of costs of veteran benefits that follow, not to mention the added entitlements to buy the votes of over 65 Republican voters with the Medicare drug entitlement.

        But Greenspan predicted that the banks and money market funds would need to flee to US Treasuries when they used their deregulation to crash the economy, requiring at least $10 trillion in T-bills.

        Republicans only want to limit debt and deficits when they are not in power to cut taxes and increase spending to buy votes.

  5. The whole argument of those calling to raise the debt ceiling is based on the premise that the Fed will be able to sustain ZIRP policies in perpetuity, and thus exponentially increasing debt is not a serious threat to future interest payment obligations from federal revenues. It’s a fundamentally ignorant position towards basic math and an unwarranted faith in bond rate supression.

    There’s a reason Yellin is the new Fed chair nominee, and it’s not because she’s determined to ramp back the money printing.

    1. But inflation isn’t a problem and never will be. What don’t you understand?

  6. As a beer drinker there are few things I less like seeing than an image of Obama with a beer in his bony little hand. Is nothing sacred anymore?

  7. It would seem to me that an investor would actually think the debt limit battle was a good thing. It could be interprested that the United States is starting to become serious about controlling its debt and is becoming a little more fiscally responsible.

    What puzzles me is that inflation hurts the poor much more than the rich since the rich have assets that will generally keep up with inflation. Also, inflation will necessarily be one tool used to address the debt problem (changing inflation measurements to understate true inflation), so those on Welfare or Social Security will be hit by this too. Yet, those left-of-center seem more enthusiastic about policies that increase inflation. Odd.

    1. those left-of-center seem more enthusiastic about policies that increase inflation.

      Stupid is as stupid does.

    2. Because they don’t understand real world financial consequences. They’re almost all rich lawyers that haven’t had a job outside of govt in decades

  8. When confronted with these arguments, many a “progressive” I know will simply turn it all around and blame the Bush administration. This is as if to say that when one partner managed finances, they overspent, so, now we get to do the same. Some more thoughtful or moderate democrats claim the deficit can be overcome similar to how it was in the 1990s – through technology revenues from future inventions unknown at this time. I look at them like the completely crazy people they truly are…

  9. Is we-hit-the-ceiling a sufficiently more realistic option than Congress-actually-lowers-spending-sensibly, that its greater drawbacks are less of a problem at the end of the say?

    Or is it that the crisis is just that bad? I know it’s tempting to make analogies with drug addiction, where the best approach can be instant-cold-turkey. But the measured tone of the economic expertise in this article (and others like it) suggest that it’s not quite there.

    Then again, are they just speaking quietly for whatever reason, and what they WANT to say is “God Almighty, let’s hope Congress isn’t crazy enough to raise the debt ceiling for any reason, it has to stay put now.”

  10. I imagine the morning after will look like the scene from Planes Trains and Automobiles, with Obama and Boehner waking up and realizing those aren’t pillows.

  11. But, but, but… what about the INEQUALITY?!!

  12. my friend’s step-sister makes $84/hr on the computer. She has been laid off for nine months but last month her check was $21144 just working on the computer for a few hours. Continue Reading
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  13. Well said. But it’s worth adding that the various convergent economic metrics are dealing with averages over time. The magnitude and context of our debt, plus the now global market for debt, could predispose us toward extreme shifts once a “tipping point” is reached. The long-term degradation of our debt worthiness, could well result in negative feedbacks that go way beyond knocking a point or two off growth.

  14. But, but… didn’t Keynes win the rap battles? Gotta keep that money flowin’

  15. Academic social studies are mostly pointless, especially in economics. I can go dig up a pile of studies that refute all the things stated by these studies. Yay. Who cares?

    Let’s try a real subject: History. Has there ever been a great power that did not pass into financial oblivion? That paid its debts back honestly after racking up epic bills? That did not defraud the people of not just their money, but the quality of the money itself if given the chance? Nope.

    The only ones who got let off that hook are the ones that got conquered by someone else. The American Empire will be no different.

  16. First, I totally agree that we need to decrease the amount of debt. But is the case solid that these high debt levels are the cause of slower economic growth, or are they just correlated? High debt levels would be consistent with countries at war, countries in economic depressions, countries that are shifting towards totalitarian, or some combination of the three. Wars and totalitarianism would slow down growth, depressions could have a strong rebound of high growth, unless the leaders use it to turn totalitarian. I just wonder about the claim that high debt leads to lower investment. It probably does to some extent, but maybe other factors are also at work.

  17. Since I started fre+lancing I’ve been bringing in $90 bucks/h? I sit at home and i am doing my work from my laptop. The best thing is that i get more time to spent with my family and with my kids and in the same time i can earn enough to support them… You can do it too. Start here.for more work detail go to tech tab.
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  18. my buddy’s aunt makes $87 an hour on the internet. She has been laid off for six months but last month her payment was $19984 just working on the internet for a few hours. great post to read
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  19. This article would have more credibility if the author did not mistakenly use “percent” when he means to use percentage point. This mistake is made throughout the article. For example, a growth rate of 3.5% being reduced to 2.3% is not “a drop of 1.2%”, but is a drop of 1.2 percentage points. Reducing a growth rate of 3.5% by 1.2% would give one a growth rate of 3.458%, whereas reducing it by 1.2 percentage points would produce the correct 2.3% rate. What’s amusing about this mistake is that Rogoff and Reinhart made a similar error when they incorrectly misquoted an IMF paper on the subject.

  20. “As it happens, America’s debt-to-GDP ratio climbed from around 60 percent in 2003 to a projected 108 percent this year.”

    But in 2000, the CBO projected debt-to-GDP ratio in 2010 was 7%.

    But that was before Bush and the Republicans boosted Federal spending by several trillion dollars and paid for the higher spending with tax cuts.

  21. damn squirrels! I had posted an eloquent dissertation showing how the problems of our Republic our compounded by a press completely determined to advance the Democrat story line, abetted by a public school system that indoctrinates our children to the socialist world-view, but you all will never be able to read it. I do feel bad for you. BTW, I should have kept track of what specific day I made my “no paying taxes pledge”, but I didn’t. So, I can’t tell you exactly how long it’s been, but I am STILL refusing to pay any income tax to this illegitimate Police State!
    Vive la libert

  22. $53,000 compounded annually for 20 years at 2.2% is $81,902.
    $53,000 compounded annually for 20 years at 3.2% is $99,511.
    (both numbers rounded to nearest whole dollar)

    Maybe if you’re going to write an article about economics you
    should take at least one class in the subject and learn how to
    use a calculator.

  23. my roomate’s mother makes $82/hour on the internet. She has been without a job for 9 months but last month her check was $15166 just working on the internet for a few hours. look at this now
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