The Perils of Rising Government Debt

Economic Analysis of Looming Debt Crisis

Just 2 years ago, the Congressional Budget Office [CBO] was projecting a U.S. Federal budget deficit of less than $250 billion in 2010, or 1.5 percent of gross domestic product [GDP], with a debt level just under the long-term historical average. Today, a budget deficit measured in billions seems almost quaint. CBO’s most recent tally of the likely deficit this year stands at $1.5 trillion, just more than 10 percent of GDP, with publicly held debt exceeding 60 percent of GDP and poised to continue rising.

The sources of this swift and sharp deterioration in Federal finances are easy to identify: a deep economic recession and financial crisis shrank tax revenues while record spending across the entire government – from temporary initiatives aimed at addressing the financial crisis, to permanent expansions – caused the public debt to soar. The exact consequences of the U.S. fiscal position may be difficult to forecast precisely, but they will undoubtedly be negative. The Federal Government’s unsustainable budget path has often been cast as a longer-term problem, or even an economic hypothetical. But fiscal risk has shifted to the foreground in recent months.

The sovereign debt crisis playing out in Greece and other highly-indebted European countries provides a cautionary tale in real time of the rough justice of the marketplace and the severe economic turmoil that can be inflicted on profligate countries. Over the past 2 years, the U.S. has seen just how quickly a severe economic and financial crisis can create a real fiscal mess. Looking ahead, that causality will likely shift, and the growing risk is that the government’s unsustainable fiscal path could suddenly engender an economic crisis.

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