The short-term risks of growing national debt

The Congressional Budget Office estimates that a growing level of debt would increase the likelihood of a sudden economic crisis.

By , Guest blogger

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    In this October 2006 file photo, $20 currency notes are seen at the Bureau of Engraving and Printing in Washington. There are significant immediate economic impacts, in addition to the long-term dangers, of allowing the national debt to grow.
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Nice issue brief just released by the Congressional Budget Office. It explains that besides the “gradual consequences” of the gradual worsening of the fiscal outlook, there are these shorter-term risks to the economy:

"Beyond those gradual consequences, a growing level of federal debt would also increase the probability of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget, and the government would thereby lose its ability to borrow at affordable rates. It is possible that interest rates would rise gradually as investors’ confidence declined, giving legislators advance warning of the worsening situation and sufficient time to make policy choices that could avert a crisis. But as other countries’ experiences show, it is also possible that investors would lose confidence abruptly and interest rates on government debt would rise sharply. The exact point at which such a crisis might occur for the United States is unknown, in part because the ratio of federal debt to GDP is climbing into unfamiliar territory and in part because the risk of a crisis is influenced by a number of other factors, including the government’s long-term budget outlook, its near-term borrowing needs, and the health of the economy. When fiscal crises do occur, they often happen during an economic downturn, which amplifies the difficulties of adjusting fiscal policy in response.

If the United States encountered a fiscal crisis, the abrupt rise in interest rates would reflect investors’ fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation. To restore investors’ confidence, policymakers would probably need to enact spending cuts or tax increases more drastic and painful than those that would have been necessary had the adjustments come sooner."

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In other words (or in “EconomistMom words”), the more we put off coming up with a sensible weight-loss program which combines a reasonable diet (spending restraint) with a decent amount of exercise (revenue increases), the more likely we’ll end up binging and purging–which is never a sustainable strategy.

And speaking of that optimal weight-loss program, the Center on Budget and Policy Priorities makes a recommendation for letting the upper-income Bush tax cuts immediately expire as scheduled, but permanently extending the “middle-class” portions proposed by President Obama. My reaction is that’s still not enough exercise as well as not the most effective exercise. More on what I mean by that later this week.

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