High debt will make it harder to control inflation


In the 1930s, President Herbert Hoover liked to say that blessed are the children since they will inherit the national debt. He must be turning in his grave today and he must have pity on our children when he learns that for the first time our national debt has exceeded 30 trillion dollars. Relative to the size of the economy, our level of public debt is now higher than it was at the end of World War II.

While Hoover might have worried about a large national debt, today that doesn’t seem to be too much of a concern to most politicians and academic economists.

Having drunk from the source of modern monetary theory and convinced that interest rates will remain low forever, our politicians and academics are unfazed by record peacetime budget deficits and unprecedented debt levels. In their minds, high levels of public debt do not matter. This is all the more surprising since, as Kenneth Rogoff and Carmen Reinhart of Harvard have reminded us, history is littered with too many examples of countries having experienced severe economic crises after embarking on paths of unsustainable public debt.

The main problem with a high level of public indebtedness is that it imposes large obligations on the government to pay future interest. This leaves little room for other public spending and makes it difficult for the government to control the budget deficit. Failure to control the deficit in turn risks keeping public debt on an ever-increasing trajectory. In this context, one should be deeply concerned that the Congressional Budget Office, a non-partisan body, projects that, on current trends, the nation’s public debt-to-GDP ratio will roughly double from around 100% currently at 200% by 2050.

A high public debt level seriously compromises the Federal Reserve’s ability to control inflation. In particular, it is difficult for the Fed to raise interest rates for fear of increasing the government’s interest payment burden. Such a consideration would seem particularly relevant today, when inflation is at its fastest pace in forty years and the Fed must raise interest rates significantly from its current zero limit if it hopes to put the inflation genie back in the bottle.

Especially in times of high inflation, a high level of public debt makes the country economically vulnerable. It is because we have become the largest debtor country in the world. For many years now, we have relied on the kindness of foreigners in general and the Chinese and Japanese in particular to finance our budget excesses.

If foreigners begin to perceive that we are inflating our debt, they will be reluctant to hold that debt and will demand higher interest rates to compensate them for the risk of inflation. This in turn could cause the dollar to falter, which would only add to inflationary pressures and further fuel concerns about our willingness to inflate our debt.

Unfortunately, in recent years, the lack of real support for disciplined fiscal policies has given outsiders reason to begin to doubt our political will to honor our public debt commitments without resorting to inflation. First, in 2017, at a time of considerable national economic strength, the Trump administration enacted a significant unfunded corporate tax cut that significantly increased our national debt. Then, in March 2021, against the advice of most economists, the Biden administration enacted a $1.9 trillion fiscal stimulus that contributed to our largest peacetime budget deficit on record.

If we are not to go down the well-trodden path of countries depreciating their currencies to inflate their debt, it would seem that we should take our public debt overshooting the $30 trillion mark more seriously than politicians and today’s academics don’t seem to. make. More importantly, we must shape a bipartisan consensus for responsible fiscal policies.

We owe it to our children and grandchildren.

Desmond Lachman is a resident scholar at the American Enterprise Institute. He was previously Deputy Director of the Policy Development and Review Department at the International Monetary Fund and Chief Emerging Markets Economic Strategist at Salomon Smith Barney. He wrote this for InsideSources.com.


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