With Rising Debt, the U.S. Federal Government Is in Bad Company

“”Households who buy government debt reduce their savings in productive private investments,” Kent Smetters and Marcos Dinerstein wrote in 2021 for the Penn Wharton Budget Model. “As the spending is unproductive, the economy is poorer and total savings is lower due to capital crowd out.”

“Government spending redirects real resources in the economy and can crowd out private capital formation,” they add. “An additional $1 trillion debt this year could decrease GDP by as much as 0.28 percent in 2050.”

If you take that insight and apply it to a world of governments on a collective borrowing spree, you end up with a hobbled global economy where prosperity becomes increasingly elusive.

“Medium-term growth rates are projected to continue declining on the back of mediocre productivity growth, weaker demographics, feeble investment and continued scarring from the pandemic,” note IMF’s Adrian, Gaspar, and Gourinchas. “Projections for growth five years ahead have fallen to the lowest level in decades.”

Heavy government borrowing also creates risk for the financial sector by putting banks at the mercy of massive debtors of uncertain creditworthiness. “The more banks hold of their countries’ sovereign debt, the more exposed their balance sheet is to the sovereign’s fiscal fragility,” note the IMF analysts.

Heavily indebted governments also reduce their ability to act as backstops in case of financial crisis as they become the likeliest causes of crises of the future. As they continue to borrow, they reduce the likelihood that productive private economic activity will grow them out of their financial problems.

“Higher government debt implies more state interference in the economy and higher taxes in the future,” The Economist points out in its interactive overview of global government debt. Also, add the editors, rising debt “creates a recurring popularity test for individual governments” which often goes poorly in terms of fiscal responsibility because paying outstanding bills isn’t popular with voters.”

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