The massive borrowing due to the pandemic has renewed debate over the peril posed by the national debt. Some economists fear that the United States will become stuck in a “debt trap,” with high debt tamping down growth, which itself leads to more debt. Others, including those who subscribe to the so-called modern monetary theory, say the country can afford to print more money.
Some say that servicing the debt could divert investment from vital areas, such as infrastructure, education, and research. Columbia University economist Edmund S. Phelps warned in an April 2020 CFR conference call that the mounting debt could make the government more hesitant to address climate change. There are also fears it could undermine U.S. global leadership by leaving fewer dollars for U.S. military, diplomatic, and humanitarian operations around the world.
Other experts worry that large debts could become a drag on the economy or precipitate a fiscal crisis, arguing that there is a tipping point beyond which large accumulations of government debt begin to slow growth. Under this scenario, investors could lose confidence in Washington’s ability to right its fiscal ship and become unwilling to finance U.S. borrowing without much higher interest rates. This could result in even larger deficits and increased borrowing, or what is sometimes called a debt spiral. A fiscal crisis of this nature could necessitate sudden and economically painful spending cuts or tax increases.
However, a few economists have argued that some of the debt concerns are overblown and suggest that Washington still has decades to tackle the problem. They say entitlement spending and health-care costs are not growing as quickly as predicted and that the cost of actually financing the debt—in terms of interest payments as a proportion of GDP—is at its lowest level since the 1970s. Jared Bernstein, a senior fellow at the Center on Budget and Policy Priorities, warned at a CFR meeting in May 2018 about a “deficit attention disorder” that focuses too much on the issue. “We’ve been so outspoken about the downsides of these deficits, and they haven’t materialized,” he said.
Some experts have posited that there is more room to respond to the coronavirus pandemic than others believe. CFR’s Sebastian Mallaby has noted that the inflation widely feared after the massive stimulus undertaken by central banks in response to the 2008 financial crisis never came to pass. He argues that with little inflation and interest rates at extreme lows, “the cost of national debt is lower than we thought, and the use of this emergency spending may be safer than we would have thought.”
Even with low interest rates, a country can run into a serious public-debt crisis. It can do so if, as is presently the case in Italy and to a lesser extent in the United States, it has the unfortunate combination of a high starting public-debt-to-GDP ratio, a large primary budget deficit (the budget deficit excluding interest payments), and trouble generating economic growth.
Before the coronavirus epidemic pummeled the Italian economy, Italy had a public-debt-to-GDP ratio of 135 percent. That made Italy the Eurozone’s second-most indebted country after Greece. The coronavirus epidemic will now make Italy’s already bad debt situation worse by causing the Italian economy to contract by a projected 10 percent in 2020. That, in turn, will likely result in the Italian budget deficit ballooning to around 9 percent of GDP as tax revenues decline, while Italy’s public-debt -to-GDP ratio skyrockets to a staggering 160 percent of GDP by the end of 2020.