Continuous warnings with seemingly few consequences have accompanied decades of irresponsible fiscal policy in the US. This has bred complacency, encouraging an ever more imprudent path. In the wake of a world financial crisis and a global pandemic that motivated—and normalized—trillions in spending for bailouts and stimulus, the US is racking up spending and debt at alarming rates even as stable growth and low unemployment have returned.
But unlike years past, the ramifications of this course—and the contours of future crises—have begun to emerge, posing costs and risks for both today and tomorrow. The bout of inflation experienced since 2021 provides a tangible foretaste of the potential consequences of America’s fiscal profligacy.
Meanwhile, the rise in interest rates illustrates a key hazard implicit in the country’s debt burden: An increase in interest rates balloons the interest paid on our high debt balances, fueling further rises in spending, deficits and the national debt. Finally, without action to reform unsustainable entitlement programs such as Social Security and Medicare, a crisis that weakens the country and dims the futures of those who come next cannot be avoided.
Spending splurge, inflation surge
The Global Financial Crisis (GFC) that erupted in 2008 led to a federal-spending increase that was unprecedented in our lifetimes. Already on an uptrend in the wake of the global war on terror, spending averaged $2.7 trillion (or 19.5 percent of gross domestic product [GDP]) in fiscal years 2005-08, yet ballooned to an average of $3.5 trillion (23.2 percent of GDP) in fiscal years 2009-12. And new ground was broken when annual federal deficits exceeded $1 trillion for the first time, crossing that threshold in each of those four years, hitting a peak of $1.4 trillion, or nearly 10 percent of GDP, in 2009.
Such precedents set the stage for another spending blowout in response to the COVID-19 pandemic, with the deficit hitting a high of more than $3 trillion in Fiscal Year 2020 and a spending peak of $6.8 trillion in 2021. While few now seem to question multi-trillion-dollar government fiscal and monetary interventions in the context of a crisis, it can be reasonably argued that the spending response to the pandemic was excessive.
For example, former U.S. Secretary of the Treasury Lawrence “Larry” Summers was an outspoken critic of the March 2021 American Rescue Plan Act, calling it the “least responsible” economic policy in decades and warning it would ignite inflation. (Furthermore, the momentum for spending continued quite apart from the pandemic, fueling trillions in completely unrelated expenditures through such legislations as the Infrastructure Investment and Jobs Act [IIJA], the Inflation Reduction Act [IRA] and the CHIPS and Science Act.)
Summers was prescient, as Consumer Price Index (CPI) inflation—which averaged 1.8 percent in the three years from 2017 to 2020—surged to an average of 4.6 percent from 2020 to 2023, hitting a peak of 8 percent in 2022.
Inflation creates many costs and risks for an economy. In particular, it places a disproportionate burden on lower- and middle-income families, who spend a higher proportion of their disposable incomes on necessities such as food, clothing and gasoline compared to more affluent families. The higher costs of these items thus constrain or even eliminate whatever discretionary spending or savings such households can muster. Wealthier earners also tend to own assets such as equities or homes that may increase in value with inflation, and businesses may experience margin expansions as price levels increase.
A key risk for a highly indebted country is the contribution inflation can make to triggering a debt crisis. When international investors begin questioning a country’s ability or willingness to maintain price stability, this uncertainty will spark concerns about the future values of the country’s debt obligations and quite possibly generate losses on existing positions. This will suppress demand for the country’s debt and potentially jeopardize its ability to refinance debt that must be rolled over as it matures. Such a crisis necessarily compromises the monetary authority’s ability to control inflation.
And high debt levels can themselves jeopardize a country’s ability to maintain price stability, regardless of the commitment of its monetary authority to that goal. Irresponsible fiscal policy can overwhelm monetary policy’s ability to contain inflation, as the central bank is faced with a choice between maintaining price stability or accommodating fiscal policy due to a variety of other objectives—these can include other economic goals or creating the conditions to assist the government with the challenges of managing its debt burden.
A wolf this time?
For years, many have warned that America’s burgeoning national debt leaves the country vulnerable to automatic spending increases and additional budgetary pressures should interest rates return to levels in line with historical norms. But the near-zero interest-rate environment persisting from the Global Financial Crisis until the recent increases in inflation kept this risk well contained, making those sounding alarms appear as if they were crying wolf.
However, the continued and rapid accumulation of debt over this period has merely exacerbated this risk, while past low interest rates kept it hidden. With the jumps in inflation and the accompanying increases in interest rates, the costs and budgetary implications of this threat are becoming clear—and real.
In the most recently completed fiscal year, net interest paid by the federal government on its debt surged to $659 billion from $475 billion in 2022 and $352 billion in 2021. The $659 billion also represents nearly a tripling of net interest payments over the past 10 years and an increase in net interest as a percentage of GDP from 1.3 percent to 2.4 percent.
To illustrate the implications for budgeting and the potential for interest payments to crowd out other national priorities, consider the growth of net interest expenses compared to defense spending. In Fiscal Year 2013, net interest equaled 35 percent of the defense budget, while 10 years later, it had risen to 80 percent—even as the defense budget increased nearly 30 percent during this time. The Congressional Budget Office (CBO) has even stated that it expects net interest costs (NICs) to cross the $1‑trillion mark in FY 2025 (on its way to $1.7 trillion in FY 2034), at which point it will exceed defense spending.
A weaker country, a dimmer future?
The challenges above are merely the proverbial tip of the iceberg. No one expects the fiscal picture to brighten soon. For example, the latest release of 10-year budget projections that are promulgated semiannually by the CBO forecasts that over the next 10 years, the budget deficit will never be less than $1.7 trillion, as it was in Fiscal Year 2023. Furthermore, it is projected to grow to nearly $2.9 trillion in FY 2034, thus adding another $24 trillion to America’s national debt from FY 2024 through FY 2034.
This is despite relatively optimistic assumptions underlying the CBO’s numbers, such as the absence of a recession over the next 10 years, the expiration of the 2017 tax cuts and the interest costs on the debt averaging a relatively modest 3.4 percent over that time. (Although that expectation does represent an increase over FY 2023’s 2.7 percent.)
And, of course, all of these sobering numbers are quite aside from the budgetary elephant in the room: the projected excess of entitlement benefits over tax receipts implicit in Social Security and Medicare—the two entitlement programs that threaten to eat the budget. These two programs alone generate unfunded liabilities over the next 75 years with a present value of $75 trillion, or nearly three times the 2023 US gross domestic product of $27 trillion.
Countries bearing high debt burdens experience lower GDP growth, run higher risks of inflation and ultimately expose themselves to the meaningful chance of a debt crisis. Such a crisis can devastate their economies and severely compromise the economic well-being of generations.
The inherent strength, resilience and dynamism of the US economy have allowed these risks to remain largely out of sight. But today, America seems willing to run ever more daring experiments in fiscal recklessness. An acute American fiscal crisis would be a catastrophe not just for the US and its economy but also for the world. And the most innocent victims will be the future generations, who will be denied the prosperity and economic opportunities we have enjoyed.
Unfortunately, it’s understandable that politicians, in an effort to keep winning elections, ignore tradeoffs and keep spending ever larger sums of money to bestow benefits on voters. And it’s equally understandable that voters would keep accepting, or even demanding, such benefits. But when one considers the age of prosperity we have inherited—and the shameful legacy we risk passing on to our children and grandchildren—the need to change course is imperative.
