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Stopping America’s Federal Debt Explosion

CAMBRIDGE – The US Congressional Budget Office (CBO) has just delivered the bad news that the national debt is now rising faster than GDP and heading toward ratios that we usually associate with Italy or Spain. That confirms my view that the fiscal deficit is the most serious long-term economic problem facing US policymakers.

A decade ago, the federal debt was just 35% of GDP. It is now more than double that and projected to reach 86% in 2026. But that’s just the beginning. The annual budget deficit projected for 2026 is 5% of GDP. If it stays at that level, the debt ratio would eventually rise to 125%.

Even that projection assumes that interest rates on the national debt will rise slowly, averaging less than 3.5% in 2026. But if the US debt ratio really is on the fast track to triple-digit levels, investors in the US and abroad may rightly fear that the government has lost control of the budget process.

With debt exploding, foreign bondholders could begin to worry that the US will find a way to reduce its real value by stoking inflation or imposing a withholding tax on all government bond interest. In that case, investors will insist on a risk premium: higher interest rates on Treasury debt. Higher interest rates, in turn, would increase the deficit – and thus the future level of the debt ratio – even more.