Is The Growing U.S. Debt Sustainable? Not Indefinitely, But Don't Ring The Alarm Just Yet

As the economy emerges from the recession, GDP will shift from contraction to expansion. And as Figure 2 shows, historically, the budget balance gradually improves once the crisis passes and as the recovery becomes more enduring. This, in turn, slows the rate at which debt accumulates. Interestingly, the prevailing interest-rate environment allows the federal government some wiggle room to run deficits (though, not as large as currently projected for 2020 due to COVID-19).

For instance, with the current yield on the ten-year U.S. Treasury Bond at roughly 0.7% and trend nominal GDP growth expected to be around 3.7%, the U.S. can sustain a 3% primary budget deficit (3.7% nominal growth less 0.7% interest rate). With interest rates expected to remain near historic lows for the foreseeable future, what’s clear is that financing this debt becomes less onerous.

Figure 2: U.S. Federal Budget Balance

Sovereign debt to GDP

 

The bottom line

Indeed, the U.S. is not alone in this predicament. Globally, the response to this unprecedented crisis has been similar as governments are taking historic measures to support their respective economies. That said, forever increasing the burden of debt is also not sustainable.

The path forward is likely to include a combination of fiscal discipline, improving economic growth, and low interest rates. This will, at first, facilitate stabilization, but, ultimately, bring about the gradual improvement of the debt-to-GDP ratio, moving it toward a sustainable path.

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