We're Borrowing Like Mad. Can the U.S. Pay It Back?

Economic growth was critical to the decline in America's debt-to-GDP ratio from its two previous peaks. The cost of World War II drove U.S. debt to an unnerving 109 percent of GDP in 1946, but the peace dividend and the postwar economic boom steadily brought the ratio down. Between 1981 and 1993, that ratio rose again, from 26 percent of GDP to 49 percent. It subsequently declined, thanks to the peace dividend from the end of the Cold War, the Clinton-era tax increases and a long economic boom.

It could, and probably will, happen again. But it's going to look a lot worse before it looks better. In another paper, Reinhart and Rogoff found that banking crises worldwide are typically followed by skyrocketing debt: It went up by 86 percent on average, after inflation, over three years, largely because the recessions that usually follow financial meltdowns devastate tax revenues and spur governments to spend aggressively.

So what's the moral of the story? The Obama administration should not focus on debt reduction now, which could actually undermine the prospects for a recovery in the real economy. With households and businesses trying to spend less and save more, the federal government must spend more and save less -- that is, borrow more -- in order to prevent a self-feeding downward spiral in economic activity. Once the recession is over, getting our debt burdens down will hinge on Obama's and Congress's willingness to confront the looming cost of Social Security and Medicare benefits for the aging U.S. population.

The chances of default remain pretty remote. But remote does not mean impossible. The best way to keep those chances remote is for policymakers to vow to get the deficit down once the recession is over -- and mean it.

gregip@economist.com

Greg Ip is U.S. economics editor of the Economist.