Yes, Debt Matters

Posted: Mar 27, 2014 10:55 AM
Federal debt held by the public has exploded in the Obama Era. The 2008 recession necessitated a policy response, and the Obama Administration's response was to institute a massive stimulus program on top of cratering federal revenues, which ballooned the federal deficit and added a huge amount of federal debt.


Matt Yglesias of the new Ezra Klein-helmed Vox News has a "Vox Explains" video out making the claim that this chart doesn't matter.

The U.S. government can never run out of dollars. Unlike you, or the company you work for, or the town you live in, the federal government prints dollars. Or actually, the Federal Reserve mostly makes it with computers. The only thing to worry about is inflation... If inflation gets out of control, the Fed will slow down the economy by raising interest rates... but interest rates are at the lowest they've been in 30 years, and inflation is also at record lows.

We could reduce debt with higher taxes, or by cutting benefits, but that would take money out of people's pockets. That means fewer jobs, it means lower incomes. By trying to reduce debt we could actually make the debt situation worse. So let's think of something else to worry about. Debt just isn't a problem right now.

There's an element of truth here: federal debt is especially bad in an era when inflation and interest rates are higher than they currently are. The Federal Reserve has a large cushion in those areas right now, and there's a good case that the Fed could be doing more to aid the economy. But that's not the only reason to worry about debt.

The Congressional Budget Office's recent report gives us the arguments against carrying high levels of public debt:

In the past few years, debt held by the public has been significantly greater relative to GDP than at any time since just after World War II, and under current law it will continue to be quite high by historical standards during the next decade. With debt so large, federal spending on interest payments will increase substantially as interest rates rise to more typical levels. Moreover, because federal borrowing generally reduces national saving, the capital stock and wages will be smaller than if debt was lower. In addition, lawmakers would have less flexibility than they otherwise would to use tax and spending policies to respond to unanticipated challenges. Finally, such a large debt poses a greater risk of precipitating a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.

All things being equal, less debt is better than more debt, no matter what else is going on in the economy. There may be no magic number that precipitates a financial crisis, or inhibits growth, but that underlying principle remains.

Ah, but all things are not equal. It's not simply a trade-off between less debt and more debt. The federal government could, for example, issue $25 billion of debt every year for the next ten years (and beyond) and do things with that $25 billion other than toss it into a hole. It could, say, fund universal pre-K education. At that point, we could debate the merits of that policy, but it should be noted that for whatever speculative upside any debt-financed public policy might have, the debt-financing is in and of itself a downside.

A more direct effect on the federal budget will be seen as interest rates begin to rise. The cost of more debt is very low right now, but in the next few years - potentially next year - the cost of servicing more debt grows. Indeed, the cost of servicing debt itself, at the current levels that Yglesias is unworried about, is the single fastest-growing portion of the federal budget over the next decade:

The House Committee on Financial Services recently held a hearing called "Why Debt Matters," in which budget experts like Alice Rivlin, Douglas Holtz-Eakin and Jared Bernstein testified. Rivlin, of the Brookings Institution, made the case that debt matters especially because lawmakers can't agree on how to tackle it.

It is not the inherent difficulty of the problems that is preventing us from getting our budget on a sustainable path toward higher growth and lower debt. It is the current state of partisan politics that is preventing hammering out compromise solutions to these quite manageable problems.

Debt has plateaued as we've tamed our medium-term deficit problem, but beginning in 2015 debt is projected to rise to over 80% of GDP over the next ten years, and our mandatory spending obligations will accelerate that after the next decade. Policymakers can't agree on how to reform the budget, so it's going to take time and effort to actually hammer out solutions to those problems. Basically, any meaningful policy to reduce the debt is going to have significant lag time due to partisan intransigence and political feasibility.

For the reasons the CBO laid out, debt is a problem right now, even if it's not a crisis. The crisis that America's growing debt is precipitating, however, is worth worrying about right now - and worth telling policymakers that they've got to get their act together to actually address it. In a world where policymakers moved quickly and the American people readily accepted large shifts in redistributionary policy, debt might not be a problem. We don't live in that world.