Liberals and conservatives tend to have different views of what sorts of government functions have a long-term payoff high enough to warrant deficit spending. For example, when the steep recession came, the government enacted $800 billion in spending and tax cuts paid for with borrowed money. Back to the household metaphor, it would be the equivalent of a family, with one of its earners unemployed, using the credit card to stay afloat during a difficult period, hoping to pay off the balance when conditions improve.
Is that a good use of debt or a bad one? The answer depends on your ideology.
4. The stronger the economy, the less debt we’ll have and the more we can handle.
The diligent economists at the Congressional Budget Office dutifully prepare 10-year forecasts for the federal deficit and debt, under a wide range of policies that Congress might or might not enact.
But to make those forecasts, they have to guess how the economy will do. The reality is that economic growth has a massive impact on both the scale of deficits and how sustainable a given debt level might be.
When the economy is stronger — when there is more economic activity, fewer unemployed and higher incomes — income taxes are higher. Simultaneously, there is less need for unemployment insurance, Medicaid and other social welfare programs.
Not only would a stronger economy make the deficit lower — it would broaden the nation’s capacity to handle a large debt. Just as a $1 million mortgage would be ruinous for a poor family but easily manageable for a wealthy one, the United States can handle a larger amount of debt the greater our national income.
5. Interest rates matter (a lot).
Here’s a phrase that most Americans have never heard but that will be really, really important over the coming decade: “debt dynamics.”
That’s the concept that deficits and debt have a built-in feedback loop. So when debt levels rise too high, interest rates can rise, making the debt problem all the more onerous. Debt dynamics are the reason that, even though interest rates are very low now, it is worth worrying about current U.S. debt levels.
A debt level that is completely manageable when interest rates are 3 percent can become burdensome when rates are 6 percent. Every rise in interest rates by a single percentage point increases the annual cost to service that debt by about $140 billion, or $450 for every American.
What that means is that with debt levels high relative to the size of the economy, a country loses control of its own destiny in terms of public finances. If global lenders lose faith that the U.S. government is the safest entity on Earth to lend money to, the fiscal situation would go from being a long-term challenge to a near-term crisis.
There are countries that maintain larger levels of debt than the United States, relative to the size of their economies, such as Japan and Italy. But it creates a certain national vulnerability — to the hard-to-predict whims of financial markets.
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