Trillion-Dollar Deficits Are Sustainable for Now, Unfortunately

January 4, 2013

The argument that Congress must quickly act to reign in debt and deficit spending is potent because everyone wants to avoid the debt crisis that countries like Greece, Spain and Portugal have experienced, says John H. Makin, a resident scholar at the American Enterprise Institute.

However, even with a trillion-dollar budget deficit, it is unlikely that the United States will experience a debt crisis similar to what other countries did.

  • The federal government is able to finance its deficit because of low interest rates of half a percent or less.
  • The debt-to-gross domestic product (GDP) metric used to gauge the sustainability of deficits is flawed.
  • For example, Spain and the United States have nearly identical debt-to-GDP ratios of about 80 percent.
  • However, Spain experienced a fiscal crisis that drove interest rates on its 10-year bonds to over 7 percent.

In many of the European countries that face a debt crisis, other factors combined to increase interest costs despite a relatively low debt-to-GDP ratio.

  • Spain, for instance, borrowed at low interest rates while experiencing fast growth after its entry to the Eurozone.
  • This drove up debt but growth still remained high relative to GDP.
  • However, after the 2008 crisis, when Greece revealed its poor government finances, interest rates spiked on bonds of indebted European countries, like Spain.

The United States, however, is neither like Greece nor Spain. It was because Greece failed to show the true extent of its deficit that led to austerity measures, which caused the debt-to-GDP ratio to rise.

It should be noted that the sustainability of the deficit does pose a threat to the economic well-being of the United States. For example, the Federal Reserve's monetary accommodation of debt accumulation will cause inflation to rise. In turn, this will increase borrowing costs for the government and private sector. Instead, reducing the deficit to about 3 percent of the GDP will allow the debt-to-GDP ratio to stabilize and sustainably bring down the debt.

Source: John H. Makin, "Trillion-Dollar Deficits Are Sustainable for Now, Unfortunately," American Enterprise Institute, December 13, 2012.

 

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