How much federal debt is too much?

Even before the pandemic, the federal budget deficit was approaching record levels and was adding significantly to the country’s debt burden. The economic stimulus bills passed since have been a lifeline for many, but have been funded by billions of dollars in debt. According to forecastthe bloated deficit is expected to push the national debt from 79% of GDP before the crisis to around 130% of GDP by 2030.

But, according to Harvard economists Larry Summers and Jason Furman, there has been a fiscal paradigm shift. The new paradigm suggests that public debt is not a major issue and that public borrowing for good purposes is in fact prudent. Here’s why: Interest rates are much lower than they have been in the past and are expected to stay low for years to come.

A key indicator is the real interest rate, which is a better measure of real borrowing costs than the real or nominal rate. the real rate – the interest rate minus inflation – has generally been below 1%, and often negative, during the last decade. Why? Because companies are brimming with cash and savers with few options are willing to buy government debt even at low interest rates.

Consequently, the taxpayers’ debt burden is no longer what it used to be. Before the pandemic, federal debt as a percentage of gross domestic product was double its level in 2000. But federal interest payments as a percentage of GDP were actually down. In fiscal year 2020, the US government borrowed a whopping 15% of GDP, but the 10-year government bond still paid less than 1%. Low rates are likely to continue long after the pandemic is over.

A Furman-Summers research study determined that debt burden is best measured by annual inflation-adjusted interest payments as a percentage of GDP and that anything below 2% should be sustainable. At present, it is well below. Furman recently said that far from burdening future generations, the government has a golden opportunity to fund long-standing needs.

The greatest long-term need is to tackle climate change, which in itself could cost billions of dollars. Either we tackle climate change now or we pay much later. Bill Gates recently wrote that, as terrible as this pandemic is, climate change could be worse. This is a clear and costly danger facing the world. Inventing and implementing solutions will spur a torrent of innovation and create huge numbers of lucrative jobs.

Summers is against the part of Biden’s plan that gives most citizens $2,000 in stimulus money. It is not necessary because the vast majority of workers have jobs and therefore putting extra money in their pockets could overheat the economy. He recommends borrowing money so that infrastructure spending is done within a “green” framework.

Spend your days with Hayes

Subscribe to our free newsletter Stephinitely

Columnist Stephanie Hayes will share her thoughts, feelings and fun stuff with you every Monday.

You are all registered!

Want more of our free weekly newsletters in your inbox? Let’s start.

Explore all your options

So when will we reach a “debt ceiling”? The markets will inform us by raising interest rates and lowering the value of the dollar considerably. Such changes do not happen in a vacuum. Inflation expectations are expected to rise, which economists say is unlikely. We could see a (very) short-term spike in inflation as the world gets vaccinated and pent-up demand is released.

So what can go wrong? A sequence of events that no one can imagine or anticipate – the proverbial unknown, unknowns. This risk can be mitigated by locking in low interest rates with 30-year bond issues. According to The Economist, the average maturity of US Treasury debt is 63 months. It seems prudent to extend future bond issues to 30 years, which yield less than one percent on a real interest rate basis. It’s almost free money. So let’s strike while the iron is hot.

Finally, the GOP needs to temper its opposition to deficit financing when a Democrat is president. A reminder that during Trump’s pre-pandemic tenure, the budget deficit was increased by 60%. And the tea party had turned into Lunesta Party. It must remain in hibernation.

Murad Antia teaches finance at Muma College of Business, University of South Florida, Tampa. In a previous life, he was a quantitative equity manager at a major Florida bank.