BEYOND THE NUMBERS
Rising federal debt should not deter policymakers from enacting additional relief measures to alleviate widespread hardship and keep the economic recovery from losing steam.
COVID-19, the resulting recession, and legislation enacted to fight them are driving federal borrowing and debt to historically high levels, new Congressional Budget Office (CBO) projections show. The budget deficit in 2020 will equal 16 percent of gross domestic product (GDP), CBO projects, while debt held by the public will reach 98 percent of GDP this year and nearly 106 percent by 2022 — the highest level since World War II.
Just as in World War II, the size of the emergency justifies this high borrowing — and more. The virus and recession have created severe distress. Although the labor market has improved in recent months, job growth has slowed. Unemployment remains high, especially among low-wage workers, those without a college degree, and people of color. Over 11 million payroll jobs have disappeared since February. Millions report that their families are struggling to afford food or are behind on their rent or mortgage payments.
Asked if policymakers should be concerned about rising debt, Federal Reserve Chair Jerome Powell replied, “This is not the time to act on those concerns. This is the time to use the great fiscal power of the United States . . . to do what we can to support the economy and try to get through this with as little damage to the longer-run productive capacity of the economy as possible.”
Contrary to some earlier theories, there’s no evidence of any particular dividing line between safe and unsafe debt levels. Although the debt-to-GDP ratio can’t grow forever without risking harm to the economy, it can and should grow in an economic downturn to reduce suffering and the threat to longer-term growth from a deep and protracted recession. Moreover, robust fiscal stimulus will speed a recovery and thereby lessen the rise in the debt ratio. In some circumstances, in fact, the debt ratio may eventually be lower than it would have been under a less stimulative policy.
Although large, the budgetary costs stemming from the pandemic are temporary and will have only a small effect on the long-run budget challenge. Even before COVID-19, the federal government faced a long-term budget problem. Fighting the virus and recession will cause a one-time jump in the debt ratio but little change in long-run budget shortfalls. By 2024 the annual deficit will fall to 4.5 percent of GDP, CBO now projects, about the same as it had projected before the recession.
Low interest rates are a major factor moderating the impact of higher debt. The inescapable cost of federal debt is the interest that the government pays on it. Treasury interest rates are currently quite low — in fact, negative in inflation-adjusted terms — and CBO projects them to stay below historical levels for more than a decade. As a result, even though the debt-to-GDP ratio is very high, the interest-cost-to-GDP ratio is not. Net interest costs will reach 2.2 percent of GDP by 2030, CBO projects — less than what it had previously projected, despite the higher debt, and well below the peak of over 3 percent in the early 1990s.
Low interest rates indicate that rising debt is not overheating the economy or crowding out private investment in physical or human capital that could raise future productivity and incomes. Low rates also suggest that the economy can support a higher debt ratio than was appropriate when borrowing costs were much greater.
At some point policymakers will need to address rising deficits and debt. But now is not the time to let such concerns forestall further efforts to fight the virus, care for those whom it and the recession have harmed, and restore the economy to health.
For more, see our updated paper, Rising Federal Debt Should Not Shortchange Response to COVID-19 Crisis.