Right now, there’s a whole lot of water in that tub. In fact, at about $20 trillion, the public debt is equal to the size of the economy, and it’s going to get bigger. The nonpartisan Congressional Budget Office recently projected that debt scaled to its share of the economy was expected to be 104 percent next year, and 106 percent the year after.
So, after all that, what if I told you that according to CBO estimates, the inflation-adjusted cost to the government of servicing that debt — meaning paying interest on it — is expected to be about zero, or even less than zero, over the next decade? Because that’s what the numbers show.
The reason for this counterintuitive result is neither complicated nor sleight of hand: It’s because interest rates are so low that the cost of paying for even our historically large and growing public debt is also very low, especially when we factor in inflation.
Here’s a highly simplified explanation of how it works.
Suppose you borrowed $100 at 10 percent interest. Your interest cost, or debt service, is $10 a year. Now, suppose, as the U.S. government does, you not only roll over that debt, you add to it, even double it. But also suppose that as you double your debt, the interest rate on it falls to 2 percent, or $4. Your debt has doubled to $200, but your debt service is down by 60 percent.
Next, here’s how inflation comes into play. Assume you’re still paying 2 percent interest on your debt, but inflation is also running at 2 percent. While the dollar amount of your debt grows by 2 percent each year, the real value of your debt — what it could buy in actual stuff — is not growing at all. When the real value of debt grows by zero — when 2 percent interest is offset by 2 percent inflation — that’s a big help for any entity carrying a large debt load.
Now, let’s apply all this to the government accounts. The table below shows the two oft-cited measures of public debt and deficit as a share of the economy. The debt share is headed for record territory, about to surpass its historical peak of 106 percent in 1946. Part of this is because fighting fascists and fighting infectious microbes are both expensive. And part is due to the reckless Trump tax cuts, which broke the linkage between the precrisis economy and the revenue flow to the Treasury, a point I have often stressed.
But the bottom line, in bold, shows that as debt grows over the next five years, the real cost of servicing that debt falls. If this prediction holds, it means that the rate of inflation will be higher than the rate of interest, so real debt service will actually decline.
Putting aside all the wonkery, what this is saying is as simple as it is important: If interest rates stay as low as we expect, the cost of servicing even our highly elevated debt will be uniquely low and affordable.
But will rates remain so low? In fact, what we’re seeing now is part of a long-term trend across all advanced economies (why this is occurring is a great question and the subject of a future column). These low rates persisted even before the pandemic, when economies were closing in on full capacity, a dynamic that usually pushes rates up. Moreover, broad expectations, which could of course be wrong, are that rates will stay low for at least the next decade (i.e., low relative to historical experience; we should expect some rate increases as the recovery proceeds).
Now, let’s remove our green accounting eyeshades and turn to exciting current events. The new, incoming administration will be inheriting many economic challenges which President-elect Joe Biden has listed as: the pandemic, the economic recovery, racial justice and climate change.
Biden and Vice President-elect Kamala D. Harris have an agenda with ambitious policies targeting each one of these issues (I informally advised Biden during the campaign). Legislating that agenda was never going be easy, and if the Republican majority holds in the Senate, it will be harder. Still, I take seriously the president-elect’s recent comments about reaching across the aisle, and to those rolling their eyes, I say a) he’s got to try, b) he’s just the person to do so, and c) at transitional moments such as this, politics can sometimes surprise you.
But either way, the calculations above provide solid evidence of a highly underappreciated tail wind for the new administration: To the extent that they need to deficit-finance these essential initiatives, the borrowing environment is saying “be my guest.”
To be clear, that’s not an invitation for reckless or wasteful borrowing. But it is a welcoming invitation for the four elements of the list, each one of which will have a return on investment that will far surpass their historically low costs.
It would be folly to ignore the debt and the deficit, but it would be a much bigger mistake to ignore the pent-up needs of the country and, in particular, the low cost of financing those needs.