Exploding public debt: A cause for concern?

Congress is now debating another multi-trillion-dollar stimulus package. This comes on top of already announced stimulus measures that are expected to push the federal budget deficit to $3.7 trillion this fiscal year and the federal debt held by the public to an all-time high by next fiscal year. Despite these staggering figures, a strong appetite for U.S. Treasuries remains with yields on the 10-year Treasury note stuck below 1 percent since late March.

Since the great recession, both U.S. public debt levels and government budget deficits have grown, and yet nominal and real interest rates have remained persistently low. Many now wonder if there are any downside risks to deficit-financed government stimulus. With around 40 million Americans unemployed, why not go far another massive round of stimulus?

In recent decades, critics of fiscal policy intervention contended that deficit-financed government stimulus inevitably leads to crowding out of private sector consumption and/or investment by raising the real interest rate. The post 2008-09 era showed that, despite increases in government budget deficits and public debt levels in advanced economies, there was little or no evidence of crowding out.

More recently, the 2017 Tax Cuts and Jobs Act and 2018 Bipartisan Budget Act showed that large-scale fiscal stimulus can deliver a short-term boost to U.S. economic performance without generating private sector crowding out. With monetary policy limited by the zero (or slightly negative) lower bound on nominal interest rates, and, given the muted success of past quantitative easing programs, fiscal policy has now taken centerstage. 

However, given the unprecedented scale and scope of fiscal stimulus measures employed to fight the economic devastation resulting from the pandemic, there is now a risk that fiscal interventions may go overboard.

There are at least three reasons to start to worry about the exploding public debt levels.

First, the U.S. faces a severe demographic challenge. Funding Medicare and Social Security in an era of rapidly aging population, declining birth rates and strong anti-immigration sentiments will pose a serious test to fiscal authorities.

Second, many investors are willing to hold U.S. Treasuries despite plunging yields because of the so-called “Greater Fool” theory – bondholders are willing to buy at a relatively high price (low yield) because they assume that they can sell the bond at an even higher price before the maturity date. With long-term bonds offering yields near historic lows and with an expected surge in new Treasury issuances, it is unlikely that significant capital gains can be expected in the coming years.

Third, many foreigners are growing frustrated with the inequities associated with U.S. dollar-centric global monetary order and are starting to push for a reduction in the dollar’s role in the international financial system. Furthermore, extreme partisanship and rancor in Washington, D.C., and isolationist tendencies have caused the rest of the world to doubt America’s commitment to maintaining the international liberal order. In light of these developments, future demand for U.S. Treasuries from foreign central banks may not be as strong as in the past.

In the post-COVID-19 era, the historically high debt-to-GDP ratio will raise concerns. America depends on the “kindness of strangers” to plug our national saving deficit. Easy borrowing conditions, however, may not persist for long as global saving glut shrinks and as global supply chains are restructured to emphasize resilience more than efficiency. The impact of diminished foreign appetite for American debt and a potential rise in inflation rates may outweigh the benefits from a spike in domestic private sector saving. If so, U.S. government borrowing costs will increase and the nearly four-decade long bull-run in the Treasury market will end. 

Vivekanand Jayakumar is associate professor of economics at University of Tampa. Brian Kench is professor of economics and dean of the Pompea college of business at University of New Haven.