Some policy experts who saw little need for serious spending cuts in recent decades because the government could borrow at low interest rates are now changing their tune. Their argument is that with interest rates rising and government interest payments set to become extremely expensive, it is time to adapt. While I suppose this is progress, they fail to see that the calls for cuts of the past were attempts to avoid exactly what is happening today.
The need for fiscal responsibility at the time was never based on the inability to raise additional debt. It was because the time was destined for adjustments to become necessary, and rising debt levels meant that these changes would become more painful.
Let me explain. Consider two respected economists and former senior government officials, Lawrence Summers and Jason Furman, who previously suggested that in the wake of the Great Recession, the concerns of “deficit fundamentalists” (like me) were excessive, and that some of the efforts we made to reduce debt were unnecessary.
Despite the growing national debt, interest rates remained historically low, meaning the costs of servicing it were not particularly onerous. This, they argued, led to calls to keep debt under control. In fact, those low rates would provide an opportunity to ‘invest’ in productive projects such as infrastructure and education. This spending would in turn boost productivity and increase economic growth, offsetting the future costs of debt.
Now, unlike some who subscribe to similar ideas, Summers and Furman are not extremists. They recognized that debt cannot accumulate indefinitely. But they derided calls for austerity measures in the 2010s as premature, while encouraging public investment paid for by debt accumulation.
Interest rates were undoubtedly low. As Summers and Furman highlighted in a 2019 article, “in 2000, the Congressional Budget Office (CBO) projected that the U.S. debt-to-GDP ratio would be six percent in 2010. for 2028 at 105 percent. The real interest rate on ten-year government bonds has now fallen from 4.3 percent in 2000 to an average of 0.8 percent last year.’
This thinking brings problems. First, it assumes that government officials have the right incentives and knowledge—in addition to a comparative advantage over the profit-driven private sector—to “invest” productively. Not all government expenditures qualify as productive investments, especially when most of it comes in the form of transferring wealth from one group to another and the rest is largely determined by interest group politics rather than proper cost-benefit analysis.
Second, ten-year projections are truly unreliable. Later, in 2008, CBO projected that the national debt would reach 22.6 percent of GDP in 2018. It turned out to be 78 percent. Then in 2018, CBO predicted that debt would reach 96 percent of GDP by 2028. It is now estimated that this will be 108 percent. Meanwhile, CBO projections for interest rates since the Great Recession have been higher than what they ended up being. As of last year, that has been reversed, and the actual numbers are much higher than the projection. The difference between expected interest rates and actual interest rates is likely to persist. It could expand.
Overestimating interest rates means the federal government pays less than projected. Yes Yes. However, an underestimate means higher interest payments, more loans and more debt than expected. Add to this misfortune an underestimation of the debt burden and you quickly see a lot of red ink.
That’s why it’s risky to bet on low interest rates to argue that we don’t have to worry about a growing debt burden. Interest rates are influenced by several factors and can rise quickly. In 2021, many continued to falsely claim that interest rates would not rise. Is it crazy, then, to believe that we would be in a better position to cope with the current rate hikes if the government had kept better control of its debt over the past ten to twenty years?
Finally, anyone who looked at the CBO’s budget forecasts could always see that the gap between government spending and revenues was widening. Even assuming that interest rates will not rise significantly, that no emergencies will arise that require more borrowing, and that there will be no new spending programs from Congress or the President – all things that have come to pass – the official debt projections have never looked good. Why add more debt?
Ultimately, the risks associated with high debt were never about what we could afford as long as interest rates were low. It’s always been about understanding that when change inevitably comes, we can better tackle the challenge if we’re not in over our heads.
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