The U.S. national debt has been rising at a seemingly unsustainable rate throughout the COVID-19 pandemic and the subsequent economic downturn. As of February, the U.S. debt reached over $27.8 trillion, which is 105% of domestic gross domestic product (GDP). Economists have speculated what this rapid increase of debt will mean for the future of the economy, and we examine the arguments for and the risks of this approach.
The Background
The economy collapsed early in the pandemic as states across the country implemented lockdown measures and many Americans sheltered at home. In fact, GDP, the broadest measure of the U.S. economy, fell 5% on an annualized basis in the first quarter of 2020 and an unprecedented 31.4% in the second quarter. Policymakers scrambled to support the economy during the recession and passed the $2.2 trillion CARES Act on March 27, 2020.
The CARES Act received bipartisan support and was a critical lifeline to people and businesses negatively impacted by the pandemic. The subsequent relief bills in December 2020 and March 2021, however, were met with pushback as so-called deficit hawks fought to ensure every dollar was used wisely so government debt does not hinder longer-term economic prospects.
Determining how much stimulus an economy needs is more art than science, but the debate ultimately comes down to whether taking on too much government debt will negatively impact our economy. Some economic theories, like Modern Monetary Theory (MMT) and Keynesian economics, suggest that increasing debt levels make sense to stimulate an economy, while others point to growth-hampering risks that should be seriously considered.
The Arguments for Taking on More Debt
According to MMT, a country can continuously borrow money from itself as long as it has the ability to create its own currency. Some of the basic ideas of MMT include:
- The U.S. government can add to the national debt indefinitely because it can print more of the U.S. dollar to pay back the debt and the risk of default is virtually nonexistent.
- Extra stimulus shouldn’t be worrisome because programs and initiatives, like the COVID-19 stimulus packages, will simply be funded by creating more U.S. currency.
- The increased government spending would not create inflation because there would still be unused economic capacity or unemployment. The economy would have to hit a physical or natural constraint on productivity before inflation would occur.
Keynesian economics is another theory that encourages taking on more debt. Led by economist John Maynard Keynes, Keynesian economics supports government intervention to make an economy as productive as possible. Economists that follow this way of thinking also agree that during an economic crisis, increased government spending will stabilize the economy.
For example, in response to the Great Depression, the Keynesian theory argued that:
- Deliberate government involvement in the economy will reduce the unemployment rate and government policy can address or prevent recessions.
- Lowering taxes and increasing government spending will create a budget deficit that will raise consumer demand and economic activity, which will then reduce unemployment.
- Economies require fiscal intervention to assist with stabilization.
Policies backed by Keynesian economics have been relied on and implemented in economic recoveries across the globe. Consumers represent 70% of the economy, and, with money getting in the hands of individuals, consumerism historically rises, providing an argument for the benefits of raising government debt levels.
The Risks of Taking on More Debt
We don’t believe loading up on debt should be considered riskless, and many economists and theorists believe national debt can have lasting negative implications on an economy. Here are some of the main risks:
Slow productivity. There’s a relationship between larger sustained federal debt and higher interest rates, which can decrease investments in the private sector. Higher interest rates limit the ability to invest, thereby decreasing productivity of the economy.
Higher borrowing costs. As the debt continues to rise, some investors may lose confidence in the government’s ability to pay back its debt. As such, investors may begin to demand higher interest rates on government debt to ensure greater return on their investment, which would drive up other borrowing costs as well.
Decreased ability to respond to problems. A higher level of government debt can lead to a decrease in the government’s ability to respond to future crises. Deficit hawks may be less willing to provide stimulus when the federal debt is already at record-breaking levels. If today’s debt levels are maintained, there’s a chance the government may not be able to respond as quickly.
Higher taxes. At some point, we may need to pay the piper, and this would likely come in the form of higher taxes.
Beyond these hypotheticals, inflation is the most talked about risk today. As vaccines are given and economies reopen, pent-up consumer demand could cause the economy to rebound quickly, resulting in a spike in inflation as goods and services become more expensive.
Final Thoughts
In response to COVID-19, three fiscal stimulus packages have been passed, totaling $5.7 trillion compared with $1.8 trillion during the Great Recession. Many of the COVID-19 stimulus programs have assisted the economy, allowing us to get within reach of pre-pandemic levels earlier than first forecasted. While the staggering U.S. government debt is intimidating, both MMT and Keynesian economics agree that high national debt is at times necessary and not inherently harmful.
Despite evidence that fiscal policy can be good for an economy, economists still disagree as to whether the debt will have lasting negative impacts. It’s possible that increased national debt will slow productivity, lead to higher taxes, and/or result in inflation. Despite the possibility of these negative outcomes, a temporary increase in the U.S. national debt has and will continue to benefit the economy and society during our recovery from the pandemic.
Nicole Meyers contributed to this article.
