Economic Forecasts

Federal Debt: A Heavy Load

The debt continues to grow, but record-low interest rates could ease the long-term damage.

As recently as 2007, the amount of federal government debt—Treasury securities held by the public—was just 35% of gross domestic product. At the end of 2019, it was 79%, and it’s likely to hit 104% in 2021. It only gets worse: The debt will likely rise to 109% by 2030 and approach 200% of GDP by 2050, according to estimates from the Congressional Budget Office. Those estimates don’t include another fiscal stimulus (which was being negotiated at press time) and assume Congress won’t extend tax breaks scheduled to expire in 2025.

For most of us, that kind of balance sheet would be ruinous. Interest rates would eat away at our income, making it difficult to pay expenses. Certainly, that has been the traditional view of the federal government’s debt: As rising deficits increase the amount of interest the government must pay each year, there’s less money available for other things. There have also been concerns about what would happen if China and other foreign investors were to stop buying Treasury securities. A deluge of debt would flood the market, and interest rates would have to rise to entice investors to buy it. That would cause interest rates on consumer and business loans to follow suit, which would hurt the economy.

So, should we worry? Well, yes and no.

Reasons to be fearful. All things being equal, it’s better to have low debt than high debt. Interest rates are very low right now, but they could rise in the future. Economists have generally believed that a country should try to keep debt levels as a percentage of GDP steady over time, increasing debt during economic downturns and paying it down during good times. When the debt piles up year after year, it reduces the government’s ability to stimulate the economy when the next recession comes around. Governments that try to finance their deficits by increasing the money supply (usually by having the central bank buy the government’s debt) risk triggering inflation—and in especially bad cases, hyperinflation. In Germany in the 1920s, shoppers needed a wheelbarrow full of cash to buy a loaf of bread. Scholars believe this led to political instability that fueled the rise of Adolf Hitler.

bar chart of historical federal borrowing

Reasons to relax. The U.S. has the world’s largest economy and a sound financial system. Central banks around the world hold more dollars than any other currency. Most of the world’s exports and imports are priced in dollars. The world’s investors flock to U.S. Treasury securities because they are the safest in the world, with close to zero risk of default. That allows the U.S. Treasury to continue to sell its bonds despite low interest rates.

The Federal Reserve has signaled that it won’t raise short-term interest rates for the next three years, so we can expect the rates the government pays to stay relatively low for a long time. Low rates keep interest from eating up ever larger portions of the government pie.

In addition, the debt may never have to be fully paid back. As mentioned earlier, the Federal Reserve could buy government debt. Ordinarily, that would cause inflation. But since the early 1990s, something strange has happened: Inflation has been a constant 2% to 3% every year, regardless of whether federal government debt has increased or decreased. After the government increased spending in the wake of the Great Recession, inflation barely budged. A decline in oil prices since 2015 has helped, but there has been no inflationary reaction to debt levels, even when the unemployment rate fell to 3.5% in early 2020.

Conventional wisdom has long held that a country was in trouble if its debt exceeded 100% of GDP. But Japan’s debt has risen to 266% of GDP with no accompanying inflation. The government issues bonds, and the Bank of Japan buys bonds that aren’t purchased by the public. Japan’s example has changed the way economists think of risk for highly developed countries, and many think the U.S. could tolerate a high level of debt as well.

Whichever side you come down on, you can expect the government to run large deficits (relative to GDP) for a while and the Federal Reserve to keep interest rates low for as long as inflation behaves. Although low rates hurt income-seeking savers, they tend to buoy the stock market, which is beneficial for investors who have money in stocks and stock funds. As for how this trend will affect the overall economy, the only certainty is that we’re traveling in uncharted territory.

Most Popular

Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer
Coronavirus and Your Money

Where's My Stimulus Check? Use the IRS's "Get My Payment" Portal to Get an Answer

The IRS updated its popular online tool so that you can track the status of your second stimulus check.
January 9, 2021
Biden Calls for $1,400 Payments as Part of $1.9 Trillion Relief Package
Coronavirus and Your Money

Biden Calls for $1,400 Payments as Part of $1.9 Trillion Relief Package

Under Biden's plan for a third stimulus check, the $600 second-round stimulus checks would be increased to $2,000.
January 14, 2021
6 Reasons Why Your Second Stimulus Check Might Be Delayed
Coronavirus and Your Money

6 Reasons Why Your Second Stimulus Check Might Be Delayed

The IRS started delivering second-round payments in December. If you're still waiting for your money, here's why your second stimulus check could be l…
January 9, 2021

Recommended

The Kiplinger Letter’s Must-Read Political and Economic Forecasts for 2021
Politics

The Kiplinger Letter’s Must-Read Political and Economic Forecasts for 2021

Our annual outlook explores what to expect from the U.S. economy, the new Congress and next administration, trade tensions, cryptocurrency, self-drivi…
January 12, 2021
Kiplinger's Economic Outlooks
Economic Forecasts

Kiplinger's Economic Outlooks

Regularly updated insights on the economy’s next moves.
January 11, 2021
The Janet Yellen Era: Chapter Two
economy

The Janet Yellen Era: Chapter Two

Former Fed Chair Janet Yellen, if installed as Secretary of the Treasury as expected, should help to calm Main Street and Wall Street alike.
December 26, 2020
Stephanie Link: Expect Above-Average Gains in 2021
Economic Forecasts

Stephanie Link: Expect Above-Average Gains in 2021

The chief investment strategist and portfolio manager at Hightower Advisors says profits point the way for 2021.
November 29, 2020