Loading...
June 7, 2024 • 26min
How much national debt is too much?
Planet Money
This episode of Planet Money explores the long-running debate among economists about the relationship between high levels of national debt and economic growth. After the 2008 financial crisis, governments around the world took on massive amounts of debt in an effort to stimulate their economies. This led to concerns that the debt could eventually start to drag down growth.
How much national debt is too much?
0:00
-0:00
Key Takeaways
- There are concerns that high levels of national debt can slow down economic growth, but economists have struggled to definitively prove when exactly debt becomes a problem.
- A 2010 paper by Carmen Reinhart and Kenneth Rogoff suggested that economic growth slows significantly once debt exceeds 90% of GDP, but this finding has been heavily debated and criticized.
- Economists have found that the relationship between debt and growth is complex, with factors like the type of debt, who holds it, and the interest rates mattering a lot.
- Despite the uncertainty, many economists believe the U.S. is on an unsustainable debt trajectory that will likely lead to higher interest rates and inflation, though an outright crisis is not necessarily imminent.
- Policymakers face difficult tradeoffs in trying to address high debt levels, as reducing deficits would require either spending cuts or tax increases that are politically challenging.
Introduction
This episode of Planet Money explores the long-running debate among economists about the relationship between high levels of national debt and economic growth. After the 2008 financial crisis, governments around the world took on massive amounts of debt in an effort to stimulate their economies. This led to concerns that the debt could eventually start to drag down growth.
In 2010, a paper by economists Carmen Reinhart and Kenneth Rogoff seemed to offer a clear answer - they found that once a country's debt exceeded 90% of its GDP, economic growth slowed significantly. This paper became hugely influential, sparking fierce debates and calls for austerity measures. However, the findings were later called into question when researchers found errors in Reinhart and Rogoff's data analysis.
With the U.S. national debt now exceeding $26 trillion, or over 120% of GDP, the question of when debt becomes a problem is once again a pressing concern. This episode dives into the history of this debate, the complexities involved, and where things stand today.
Topics Discussed
The Dangers of High Debt (3:44)
- Economists have long warned that high levels of national debt can be dangerous for an economy in a few key ways:
- It can lead to a "snowballing" effect where interest payments on the debt keep increasing the deficit
- It can make investors lose confidence in a country's bonds, forcing it to pay higher interest rates
- It can "crowd out" private investment as the government sucks up capital to finance its debt
- However, the exact point at which debt becomes a serious problem is difficult to pinpoint.
The Reinhart-Rogoff Paper (8:59)
- In 2010, a short 6-page paper by Carmen Reinhart and Kenneth Rogoff seemed to offer a clear answer - they found that once a country's debt exceeded 90% of GDP, its economic growth rate was about half of what it would be with lower debt levels.
- This "90% threshold" became hugely influential, with politicians and policymakers citing it as a reason to pursue austerity measures.
- However, the paper was later criticized when other researchers found errors in Reinhart and Rogoff's Excel spreadsheet data analysis.
The Global Debate Over Debt (10:36)
- The Reinhart-Rogoff paper sparked intense debates around the world, with some using it to justify austerity measures and others arguing it was being misinterpreted.
- Andrea Presbitero, an economist at the IMF, says the paper "opened up a very large body of research" as economists tried to better understand the relationship between debt and growth.
- Key questions included whether high debt causes slow growth, or if slow growth causes high debt, and whether there are different "tipping points" for different countries.
The Complexities of Debt (14:01)
- Economists found the relationship between debt and growth to be much more complex than a simple 90% threshold:
- The type of debt (domestic vs. foreign currency) matters
- Who holds the debt (domestic vs. foreign investors) matters
- The maturity of the debt (short-term vs. long-term) matters
- As the research progressed, the once-clear 90% threshold became increasingly murky, with different countries able to sustain different levels of debt.
The Fading Debt Debate (18:50)
- For a while, the debt debate faded from prominence as interest rates remained low globally, reducing the burden of servicing high debt levels.
- However, the COVID-19 pandemic and resulting government spending has pushed debt levels even higher, while interest rates have started to rise.
- This has reignited concerns about the risks of high debt, though economists still struggle to pinpoint a clear threshold.
Talking to Kenneth Rogoff (19:43)
- Kenneth Rogoff, co-author of the original 2010 paper, says he and Reinhart never intended to imply there was a hard 90% "cliff" that countries couldn't cross.
- However, Rogoff still believes high debt levels pose risks and that the U.S. is on an unsustainable trajectory, even if an outright crisis isn't imminent.
- Rogoff argues that the political dynamics make it difficult for policymakers to make the tough choices needed to rein in deficits through spending cuts or tax increases.
The Perspective of Karen Dinen (26:35)
- Karen Dinen, a Harvard economist, was more dovish on debt after the 2008 crisis, but is now more concerned about the trajectory.
- Dinen says policymakers need to be "honest" about the unsustainable path of U.S. debt, even if there's no clear magic threshold.
- She suggests that having some kind of benchmark, even if imperfect, could help force policymakers to make the difficult decisions needed to address high debt levels.
Conclusion
The debate over the relationship between national debt and economic growth has raged for over a decade, with the 2010 Reinhart-Rogoff paper serving as a flashpoint. While that paper's specific 90% threshold has been heavily criticized, the underlying concern that high debt can eventually become a drag on growth remains.
Economists have found the issue to be far more complex than a simple red line, with factors like the type of debt, who holds it, and interest rates all playing a role. And while an outright debt crisis may not be imminent, many believe the U.S. is on an unsustainable trajectory that will likely lead to higher inflation and interest rates.
Ultimately, addressing high debt levels will require difficult political tradeoffs, whether through spending cuts or tax increases. The lack of a clear consensus among economists on when exactly debt becomes a problem makes these choices even harder for policymakers. But with debt continuing to rise, the pressure to find solutions is only likely to grow.
