Fiscal Hawks’ Warning: Debt and Interest Rates Prove Them Right

As the American debt reaches a whopping $34 trillion, concerns about a debt crisis and its future implications arise. Despite previous beliefs that low interest rates could handle the debt, the 10-year Treasury rate has now hit 5%. Furthermore, bondholders’ interest in purchasing U.S. debt is declining. Politicians are often tempted to spend and print money due to continuous demands from interest groups. Economists, including Olivier Blanchard, presented theories suggesting that debt wouldn’t be a problem, but this seems to be true only under specific scenarios and may not be sustainable long-term. Similarly, Lawrence Summers and Jason Furman argued that low interest rates would allow the government to take on more debt without high debt service. However, despite the optimistic theories, the debt has continued to grow rapidly, and the latest numbers show public debt at close to $26 trillion.

The massive spending spree in response to the COVID-19 pandemic has raised concerns about the sustainability of the debt, as spending has far exceeded what was deemed necessary. Even if the interest rates remained relatively low, a debt of this magnitude would eventually become very expensive, according to the Congressional Budget Office projections. The conservative empirical literature also suggests that growing debt leads to higher interest rates. The U.S. may run the risk of ending up like Japan, with stagnant growth and flat real wages for decades due to high debt levels. Slow economic growth poses a threat not only to the economy but also to the overall societal and global climate. Therefore, the growing debt problem in the U.S. calls for urgent attention and proactive measures to avoid long-term negative consequences.