11 November 2005

Debt vs. GDP endgame

Why do we even care about the national debt?

Here are four long-term scenarios concerning the debt.

  1. We pay it off. This means some suffering, because it won't be cheap. We owe eight trillion dollars. The reward would be that we wouldn't be paying interest on the debt anymore. (There might be an economic reward, as well as the financial one; but I don't know.)

  2. We maintain it roughly at steady state, relative to inflation. This means we'd have to stop borrowing to cover the costs of present-day government programs. Assuming the U.S. economy continues to grow (an extremely safe assumption), this means the debt eventually becomes quite easy to pay off. At some point in the future, eight trillion Frosties will be chump change.

  3. We maintain it roughly at steady state, relative to GDP. This means paying more and more interest every year; but as long as GDP is growing, we're richer and richer every year, so we don't really feel it. Ever. Economists' comfort level would remain roughly level as the debt grows.

  4. We eventually default on the debt. That is, it eventually gets so out of control that we can't roll it over; not enough people will buy our T-bills anymore. Or we make a political decision to bail. From what I hear, this is an extremely bad scenario for the economy.

    Now the nature of debt is that by the time you start to feel the crunch, it's too late. All kinds of economic mayhem will happen before we reach the point of default: interest rates will rise, investment and growth will stall—but these little disasters will not stave off default. By worsening the economy and killing tax revenue, they'll probably accelerate us toward it.

I'm no genius, but it seems like a path somewhere between #1 and #2 might be a good idea. The path we're on right now falls somewhere between #3 and #4.

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