Explainer: The national debt and the risk of a fiscal crisis

Bergstresser: We’ve got a social security system, and we have the rest of the government. It’s useful to think of this as kind of a unified system. We pay into the social security system; we receive social security benefits. But where that distinction may start to matter is if we get to the point where we do not make necessary adjustments for social security. For example, you put social security on a more stable long-term trajectory when the trust fund is exhausted.

It’s not that social security would disappear, but as I understand it, at that point, benefits are cut pro rata in a way that everybody gets 78% or 80% of what they would have gotten in the absence of the end of the trust fund.

Dynan: When we see these concerning projections from the CBO, they’re actually assuming current policy prevails. That’s an important source of risk. For the entitlement programs, social security is an easier thing to project because it’s based on where the population is heading. We have a good idea of that, and it moves slowly. Other parts of the budget—defense spending, spending on climate needs—current policy is not reflecting what might emerge along those lines.

Klein: The debt-to-GDP [gross domestic product] ratio went from more than 100% of GDP in 1946 to about 20% in 1960. How did that happen and can something like that happen again?

Bergstresser: The U.S. federal debt is the accumulated stock of net borrowing that our federal government has done over time. Right now, in round numbers, the U.S. federal debt held by the public is about $31 trillion.

The debt-to-GDP ratio mostly fell in the post-war period with an exception during the Reagan administration. Then it started rising very sharply again during the global financial crisis of 2007 to 2009. The federal deficit is related to, but distinct from, the federal debt. The deficit in a given year is the amount by which outlays in that year—defense spending, net interest payments on federal debt—exceed revenues. We can also distinguish the total deficit from the primary deficit. The primary deficit is the deficit that you would have calculated if you didn’t consider the net interest payments on your existing stock of debt.

Elmendorf: That happened mostly because the government budget was roughly balanced, neither large surpluses nor large deficits. The debt, cumulative from past deficits, didn’t change very much in fact, but the economy grew a lot. The debt shrank relative to the size of the economy.  

What that required was discipline by policymakers not to say, “Wow, with the economy growing so much, we should just be able to run big deficits.” Policymakers held themselves to not spending more money than they were willing to charge people on taxes. And that discipline has unraveled increasing degrees over time. In the ’80s and ’90s, policymakers did respond to large deficits and growing debt by cutting spending and raising taxes. But in the last 25 years, there’s been no significant policy changes that reduced deficits.

Dynan: The post-WWII period was not only a period of rapid growth, but broadly shared rapid growth. We saw people across the income distribution seeing their incomes rise. That’s important context because it speaks to the politics around making these hard decisions. There’s a sense in which it may have been easier to make the hard decisions in a period where people felt they were all moving ahead in terms of what they were getting from the economy.

Klein: Who does the U.S. owe for the national debt?  

Bergstresser: Mostly the money is owed to Americans. Three quarters of the debt ends up as U.S. Treasury bonds. It’s a little unusual for individual households to own those U.S. Treasury bonds, though some do. It’s like having a life insurance policy. An insurance company has sold you a life insurance policy. When you die, they will pay your kids. In order for that policy that they have written for you to be credible, they’ve got to take your payments and invest it in financial assets. Insurance companies will back their policies with financial assets, including Treasury bonds.  

Elmendorf: The fact that there are some Americans who own the debt doesn’t mean that they don’t expect to get repaid. They expect to get repaid through taxes on other people.

In an economic sense, the assets that are being held, the Treasury bonds, are taking up space in people’s portfolios. If the insurance companies weren’t holding U.S. Treasury securities, they might be more eager to hold the securities of companies in the United States.

That eagerness to hold those securities would push down interest rates, make it easier for companies to borrow money to invest. Financial institutions would also be more eager if they weren’t holding Treasury securities to make loans to households.  

The existence of a large amount of government debt is crowding out some borrowing by households and businesses, pushing up the interest rates and the costs of that borrowing for households and businesses. That’s why it’s costly to our economy to have debt, even to the extent that it is held by other people in the same economy. 

Klein: There’s also a generational issue at play. People say we are stealing from our grandchildren. To what extent is that true?

Dynan: I think the intergenerational politics are interesting to think about. It is correct that we are leaving this debt to our children. It is quite common for our economists to talk to young people and say, “Well, don’t worry about all this debt that we’re leaving you because we’re going to have so much productivity growth that the standard of living is going to be so much higher as you age.”  

But I don’t think young people necessarily take that much comfort from that idea. We are leaving other problems to them as well. So yes, maybe they’ll have a higher standard of living. You might say they’ll have greater capacity to pay off this debt. But on the other hand, we’re leaving climate problems to them. We are possibly leaving national security problems to them. We’re facing a world where AI could be very disruptive and cause worker displacement, job loss that is harmful to future generations.

Klein: What would a fiscal crisis look like?

Dynan: I think the first thing that you would see would be rising interest rates. That itself is going to make the situation even worse because when interest rates go up, then the government has to borrow more to fund higher interest payments on debt. I think the first place you’re going to see distress broadly is in financial markets. As interest rates rise, you’re going to see firms having the value of the assets they hold drop. That’s going to cause them to then deleverage themselves, try to reduce their debt, sell off assets further, which would cause further declines in asset prices.  

I think financial banks would become less willing to lend, and the rates at which anybody was getting credit would be higher. You’d see distress in financial markets. As it did during the great recession that followed the global financial crisis, that would hit the economy hard. Firms wouldn’t be able to borrow, conduct business, and keep people employed. People would spend less. That in turn would cause job loss. You could spiral from there.

Klein: How would you advise journalists to explain these issues to their readers and make it transparent about what the problems are with a very large debt and potential fiscal crisis?

Elmendorf: The key here is to recognize that if the government is borrowing a lot of money, it is borrowing it from somebody else who is expecting a return. In any situation when some entity is borrowing more and more, the people who are lending that money are going to get more and more concerned that something will go wrong.

That’s the situation that the U.S. government is in now. It can’t go on indefinitely. Something will have to change, but the longer we wait, the bigger the risk that something will go wrong first or that investors, people lending money to the government, buying those securities, will get nervous and start demanding higher interest rates.

Dynan: One of the things I emphasize in my class is that these macro events have to do with the financial system. A lot of people think, “Well, that’s not my world. It doesn’t really affect me.” Emphasizing the real human costs, which is what I try to do in my teaching, is important.  

We had this great recession. It started as a financial crisis having to do with a lot of things. But then it had tremendous human costs in terms of job loss.  

Most economists believe the government had an insufficient fiscal response, and that just exacerbated the pain. Trying to make it relevant to people is an important thing that journalists could be doing.

The complete webinar can be viewed on the Shorenstein Center’s YouTubeTube channel.  

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Photography by Rick Diamond/Getty Images for Peter G. Peterson Foundation and Martha Stewart