In addition to showing the path of future debt, CBO's Long-Term Budget Outlook described the consequences of a large and growing federal debt. The four main consequences are: Show
According to the report, debt held by the public will rise dramatically in the coming decades, reaching 106 percent of GDP by 2039. The below graph shows the projected increase of the federal debt held by the public from 2014 (dashed line) through 2039 under CBO's extended baseline. Debt rising to this nearly unprecedented level will have many negative consequences for the economy and policymaking. Lower National Savings and Income Large sustained federal deficits cause decreased investment and higher interest rates. With the government borrowing more, a higher percentage of the savings available for investment would go towards government securities. This, in turn, would decrease the amount invested in private ventures such as factories and computers, making the workforce less productive. As the CBO notes, this would have a negative effect on wages:
It is worth noting that the higher interest rates would increase incentives to save. But, the CBO qualifies:
Although deficits increase demand for goods and services in the short-term, this boost would not be sustained once the economy fully recovers. Stabilizing forces such as price or interest rate rebounds and actions by the Federal Reserve would push output back down to its potential growth path. Interest Payments Creating Pressure on Other Spending As interest rates return to more typical levels from historically low levels and the debt grows, federal interest payments will increase rapidly. As interest takes up more of the budget, we will have less available to spend on programs. If the government wants to maintain the same level of benefits and services without running large deficits, more revenue will be required. As the CBO states:
If these cuts reduced federal investments, they would reduce future income further. If lawmakers continue running large deficits to provide benefits without raising taxes, CBO warns that larger deficit reduction will be needed in the future to avoid a large debt-to-GDP ratio. Decreased Ability to Respond to Problems Governments often borrow to address unexpected events, like wars, financial crises, and natural disasters. This is relatively easy to do when the federal debt is small. However, with a large and growing federal debt, government has fewer options available. For example, during the financial crisis several years ago, when the debt was just 40 percent of GDP, the government was able to respond by increasing spending and cutting taxes in order to stimulate the economy. However, as a result, the federal debt increased to almost double its share of GDP. As CBO warns:
Given the potentially devastating effects of various types of crises, it is important maintain our country's ability to respond quickly. High and rising federal debt, however, decreases the ability to do so. Greater Risk of a Fiscal Crisis If the debt continues to climb, at some point investors will lose confidence in the government's ability to pay back borrowed funds. Investors would demand higher interest rates on the debt, and at some point rates could rise sharply and suddenly, creating broader economic consequences:
Though there is no sound mechanism for determining if and when a fiscal crisis will occur, according to the CBO, "All else being equal...the larger a government's debt, the greater the risk of a fiscal crisis." * * * The longer Congress waits before addressing our debt, the larger the changes will have to be. Avoiding large disruptions through timely action is in our best interest. See our paper summarizing CBO's long-term outlook or the other entries in our blog series for more analysis. How does the US national debt affect the federal government's fiscal policy?It funds pensions and other programs, such as Social Security in the U.S. The federal government adds to the national debt whenever it spends more than it receives in tax revenue. Each year's budget deficit is added to the debt, while each budget surplus is subtracted from it.
What is the impacts of a huge and growing US national debt on the US economy?The higher the national debt becomes, the more the U.S. is seen as a global credit risk. This could impact the U.S.'s ability to borrow money in times of increased global pressure and put us at risk for not being able to meet our obligations to our allies—especially in wartime.
How does fiscal policy lead to budget deficits and increase in the national debt?A government runs a fiscal deficit when, for a specific period, it spends more money than it takes in from taxes and other revenues, excluding debt. This gap between income and spending is subsequently closed by government borrowing, increasing the national debt.
What is the relationship between fiscal deficit and national debt?What is the difference between the deficit and government debt? The deficit is the difference between government revenue and spending, usually measured over a single financial year. Debt is the total amount owed by the Government which has accumulated over the years. Debt is therefore a much larger sum of money.
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