July 13, 2023
The federal government is expected to borrow about $1.5 trillion this year, and that number is expected to nearly double over the next decade. One consequence of issuing such large Bunds is that it could “crowd out” private sector investment, making the economy less productive and slowing wage growth.
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How does federal borrowing affect private investment in the economy?
To cover its budget deficits, the federal government raises money by issuing debt in the form of government bonds. This debt is often purchased by investors such as banks, mutual funds, corporations and individuals as it is generally considered a safe investment. However, the cash used to purchase this debt could alternatively be used for private company investments. As a result, as government debt increases, there are fewer funds available for other investments, which can hamper economic activity.
In addition, increased federal borrowing is putting upward pressure on interest rates. A study by the Congressional Budget Office (CBO) found that every 1 percentage point increase in the debt ratio raises 10-year inflation-adjusted interest rates by 2 to 3 basis points (0.02 to 0.03 percentage point). The debt ratio is currently 98 percent, and CBO projects it will rise to 112 percent over the next decade. So, by CBO’s standards, interest rates would be about 0.3 to 0.4 percentage points higher than what would otherwise be due as the country’s debt levels climb.
Higher interest rates raise credit prices, thereby discouraging private investment. According to the CBO estimate, the net result of this compromise is that for every dollar the federal deficit increases, private investment would fall by 33 cents.
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Why is more debt important for the economy?
Increased debt could slow economic growth and lower wages. Since 2019, the debt ratio has increased by almost 20 percentage points from 79 percent to 98 percent. CBO predicts the rate will continue to rise, rising to 181 percent by 2053 if applicable laws remain generally the same. In a scenario where discretionary spending stays around current levels (rather than declining) and revenues return to their 50-year average (rather than increasing), CBO forecasts the debt-to-GDP ratio would rise to 262 percent; This trajectory would reduce gross national product by 4.4 percent from baseline and reduce income by $4,900 per person (in today’s dollars).
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Diploma
There is a direct and vitally important link between the country’s fiscal position and the economic outlook through the impact on private investment and interest rates. The federal government has the power to make taxes and spending fair, foster growth throughout the economy, and invest in national priorities. But it must also be careful to do so effectively and responsibly, ensuring that investment is not held back, which would undermine the opportunities and prosperity of future generations.
Photo Credit: Photo by Jemal Countess/Getty Images
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