The most important strategy to reduce the burden of the federal debt is through strong sustained economic growth. But growth itself is likely to be a casualty of irresponsible fiscal policy.
The US Probably Won’t Grow Its Way Out of Debt
A number of US leaders have suggested that the answer to the nation’s fiscal woes is to be found not in Congress but on Wall Street and Main Street. Before he was appointed to President Trump’s Department of Government Efficiency, then-Presidential challenger Vivek Ramaswamy promised 5% GDP growth as the answer to the apparent dilemma between revenue growth and spending cuts.
He is not alone. At the NYTimes Dealbook Summit in December of 2024, Jeff Bezos said the same: “You’re going to solve the problem of national debt by making it a smaller percentage of GDP, not by shrinking the national debt.”
Most economists see debt-to-GDP as the most important measure of whether debt has gotten out of control, so accelerating GDP is a plausible strategy for maintaining fiscal health.
That said, while any realistic plan to grow real GDP by 5% should be considered, betting the country’s fiscal and economic future solely on that outcome is risky and probably a dangerous strategy. For one thing, no decade in the last century and a half has seen that rate of sustained growth in the US economy. For another, positioning GDP growth as an alternative to tough political choices is to miss entirely just how vulnerable economic growth itself is to America’s worsening fiscal outlook.
How did it get like this?
In the early 2000s, the US debt-to-GDP hovered around 35%. Some of today’s most strident debt critics were, back then, warning people (and politicians) not to cry wolf. But in the wake of the 2008 crisis, attempts to ward off economic free-fall gave worries about deficit spending a back seat as President Obama and a majority-Democratic House and Senate passed the American Recovery and Reinvestment Act, a 2009 stimulus of nearly $800B, paid for entirely by deficit-spending.
Deficit hawks warned of a fiscal Armageddon, and the 2010 midterms handed the spending package a strong rebuke.
Progress was short-lived. After a few years of lower deficits (still adding to the debt every year, just less than before), Congress returned to the post-2007 trajectory. But the long-feared judgment day did not arrive. Federal Reserve policy in the wake of the 2008 crash drove a two-decade slide in interest rates even lower, and those low rates held the costs of maintaining new debt in check.
Leading economic voices suggested that the age-old debt consensus – that growing government debt drives interest rates higher and introduces recessionary pressures into the economy – might be ripe for revision. And buoyed by this seeming discovery, politicians and economists confidently hailed a new era of widespread government spending, fueled by safe debt. Allusions to the New Deal have not been in short supply.
There are two nagging problems with this perspective.
First, it left the government with few options in the face of a global pandemic, which threatened the core of the economy. In the wake of the pandemic, Federal Reserve policy drove real rates below zero, leaving a government hungry to stimulate the economy with few options other than to print money. In the subsequent 4 years, the government printed 80% of the entire amount of US currency in circulation today.
The resulting wave of inflation drove an about-face from the Fed, and a two-year period of raising rates and offloading its assets showed that safe, low interest-rate debt might not be as available as before. Under the weight of elevated rates, the US spent more on interest payments in 2024 than its entire defense budget.
Second, a number of economic analyses in the last two decades have reaffirmed the classic link between government debt and interest rates. The three-decade interest rate slide, some economists have argued, might be due to countervailing factors – such as an aging population, slowing growth in productivity, and aggressive foreign demand for US debt – overriding the expected outcome in this case.
But there are reasons to think that US productivity may grow even in spite of an aging population, thanks to medium-term immigration trends and technologies that look to increase the leverage on human inputs faster than those inputs are shrinking.
Also, foreign demand for US debt is at least not increasing, with our greatest creditor China decreasing its holdings for the last several years and runner-up Japan starting to cash in its treasuries as well. Increasingly, it looks as if the era of cheap government debt is over.
And more expensive debt, as the last two years have shown us, can hobble an economy.
If, as we have suggested earlier, the CBO has been optimistic in the current-law basis of the estimates that underlie our proposals, and the US debt actually increases to 200% or more during the 30-year window, differences of one percentage point in interest rates will account for 2% of GDP in interest payments alone. Current annual deficits equal about 6% of GDP.
At a (very possible) rate of 5%, 2054 will find the government spending as much as 2/3 of all federal tax revenues (projecting forward current tax rates) on interest payments alone. Those tax rates almost certainly are inadequate, as interest payments of that magnitude will require significant taxes on the middle class (similar to European VAT regimes) or inflation-driving trips to the printing press just to keep the government running – in either case vastly suppressing consumer purchasing power.
At the same time, rising interest rates will also drive the acquisition of even more new debt than is currently in CBO’s projections, creating the so-called debt spiral that will be the clear sign of a fiscal crisis.
Vast government demand for borrowed funds will make them both too expensive and too scarce for the private investment that has fueled a half-century of enormous, diversified, stable growth for the US.
For comparison, the European Union, with a population slightly larger than that of the US, boasts only 13 companies, founded within the last 50 years, that have achieved a market capitalization of $10B. The United States has more than 40 times that many!
But if Europe is a parable for regulatory crowdout and a tax system that punishes investment growth, it is also a portrait of what the US economy could become over the next half-century, with the albatross of national debt hung around its neck.
Key leaders see economic growth as perhaps the greatest hope for a sustainable fiscal future. The “to-GDP” side of the Debt-to-GDP equation is less susceptible to political gridlock and perverse Congressional incentives to ignore tough problems.
But it is that very economy that is threatened by a debt crisis. With a decreasing foreign and public market for US treasuries, US investors and businesses will continue to play the primary role in financing the government’s debt. By 2054, most government spending is projected to be debt-financed. And the opportunity cost of all that financing simply is the private-side investment in growth that so many are relying on to save the government from the consequences of its current path.
The return of bond vigilantism may be inconvenient for political leaders, but it is a perfectly coherent recognition of the fact that failure of fiscal leadership endangers the very economy it needs.
Fed Chair Jerome Powell was right during his own address at the 2024 NYT Dealbook Summit to point out that the current fiscal path is unsustainable.
The US economy is still our greatest fiscal asset. But mismanagement has the power not only to crush the government’s ability to act but that of the private sector as well.
No doubt, the US economy has a powerful role to play in ameliorating the US fiscal position. But if Congress and the White House do not take seriously its obligation to protect the fiscal future of the country, the time will very likely come when even the economy cannot lift the weight to pull us out of a crisis.