“In particular,” the CBO said in its report, “the projected amounts of debt would: Reduce national saving and income in the long term; increase the government’s interest costs, putting more pressure on the rest of the budget; limit lawmakers’ ability to respond to unforeseen events; and make a fiscal crisis more likely.” “Federal debt held by the public ballooned in the past decade,” the report noted.
The CBO projects that the federal debt held by the public is on its way to unprecedented levels as a percentage of Gross Domestic Product: “If current laws governing taxes and spending did not change, the United States would face steadily increasing federal budget deficits and debt over the next 30 years, according to projections by the Congressional Budget Office. Federal debt held by the public, which was equal to 39 percent of gross domestic product (GDP) at the end of fiscal year 2008, has already risen to 75 percent of GDP in the wake of a financial crisis and a recession. In CBO’s projections, that debt rises to 86 percent of GDP in 2026 and to 141 percent in 2046—exceeding the historical peak of 106 percent that occurred just after World War II. The prospect of such large debt poses substantial risks for the nation and presents policymakers with significant challenges.”
The first chapter of the outlook—“The Long-Term Fiscal Imbalance”—includes a subsection titled “Greater Chance of a Fiscal Crisis,” which explains how such a crisis could unfold: “A large and continuously growing federal debt would make a fiscal crisis in the United States more likely. Specifically, investors might become less willing to finance the government’s borrowing unless they were compensated with high interest rates. As a result, interest rates on federal debt would abruptly become higher than the rates of return on other assets, dramatically increasing the cost of future government borrowing. In addition, that increase would reduce the market value of outstanding government bonds. If that happened, investors would lose money. The potential losses for mutual funds, pension funds, insurance companies, banks, and other holders of government debt might be large enough to cause some financial institutions to fail, creating a fiscal crisis. A fiscal crisis also can make private-sector borrowing more expensive because uncertainty about the government’s responses can reduce confidence in the viability of private-sector enterprises.
“Unfortunately, no one can confidently predict whether or when such a fiscal crisis might occur in the United States. In particular, the debt-to-GDP ratio has no identifiable tipping point to indicate that a crisis is likely or imminent. All else being equal, however, the larger a government’s debt, the greater the risk of a fiscal crisis. “The likelihood of such a crisis also depends on economic conditions. If investors expect continued economic growth, they are generally less concerned about the government’s debt burden; conversely, substantial debt can reinforce more generalized concern about an economy. Thus, fiscal crises around the world often have begun during recessions—and, in turn, have exacerbated them. “If a fiscal crisis occurred in the United States, policymakers would have only limited—and unattractive—options for responding. The government would need to undertake some combination of three approaches: restructure the debt (that is, seek to modify the contractual terms of existing obligations), use monetary policy to raise inflation above expectations, and adopt large and abrupt spending cuts and tax increases.”
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