One Economic problem in America
Economic Consequences of Rising U.S. Government Debt
There has been a rapid increase in the amount of federal government debt over the years and this has sounded an alarm to the public and the policy makers. The United States federal government has seemingly unblocked the country from accessing at low-interest rates. From the past historical statistics, the United States Treasury gains have always been lower as compared to the growth rate of the U.S. This paper aims at examining the ramification of debt financing at the low-interest rates. With the short maturity period of the United States public debt, a minimum of 2.5 trillion dollars in a year, the investor expectations should be given a high consideration. The excessive debts that the U.S have justifies some reasonable doubts concerning monetary stability and solvency and hence undermining the financing strategy under the perception that the United States is safe from its debts.
The United States citizens and the policy makers are concerned with the rapidly growth of the debts incurred by the federal government. The ratio between the public debt and the GDP has been on the rise from 36.2% in 2007 to 62.2% by the end of 2010. Analysts predict that under the current policies, the debt to GDP ratio is expected to increase further to more than 80% by 2021 (Aizenman & Marion, 2009). These statistics make one to wonder if there are consequences of this continuous rise in the federal government debt. This paper will examine a proper analysis of the U.S debt must account for the ability of the government to issue a debt with interest rates that are averagely below the United States economic growth rate. Further evidence points out that low-interest rates are awarded due to a perception that the country is safe, with a secondary role for the effects on liquidity (Christiano, Eichenbaum & Rebelo, 2009). To ensure that the United States refinances its debts, the federal government should ensure that buyers of the government bonds will remain totally convinced of the solvency of the government. Too much debts provide a justification of reasonable doubts about inflation and solvency (Voxeu.org). This undermines the financing strategy that was built on the perception of safety.
One should concede from the outset that most of the economist have a positive point of view of deficit spending at the moments of a recession (Council on Foreign Relations). Most of the new Keynesian models indicate a significant fiscal multiplier. Multiplier effects usually tend to be empowered by the zero interest rates and by future stabilization expectations. Some economists argue that the United States economy is suffering from a Fisherian debt deflation, which can be corrected by dynamic deficit spending (Fleming, 2000). The federal government’s solvency and the how they have access to refinancing has always been ignored by most people; hence one is left with many questions such as what, if anything, may discourage or limit the government’s accumulation of debt?
The conceivable repercussion of the increase in the government’s debt is an increasing concern about default and monetization. Most of the rating agencies have always been using the debt/GDP and other related rations like the debt/revenues so as to come up with sovereign credit evaluation rating. It is illuminating to differentiate the debt sustainability questions from the questions regarding confidence crises and credibility (Christiano, Eichenbaum & Rebelo, 2009). The coherent answers concerning debt sustainability in the United States requires more focus of analysis. One should reject the view that there exist an opportunity for the U.S government to offer a debt without rolling it over with interest. In addition, people should worry about the government’s prowess to offer the stated debt service during harsh periods that impose further constraints. In this case, the country should ensure that the constraints of the inter-temporal budget are satisfied. A prospect of rolling over debt with a stated interest cannot be put into dismissal since the average interest charged on the public debt imposed on the country has always been less than the country’s economic growth rate (Aizenman & Marion, 2009).
Under a speculative setting, debt sustainability entails that the main surplus should be able to respond to the economic blows that fluctuates the ratio of debt-GDP. Anytime there is an increase in the level debt-GDP ratio due to some unexpected spending or a low rate of economic growth, the fiscal policy should respond in order to restore the debt equality and the present value of the primary surpluses. A fiscal reaction function is a systematic response to the main surpluses that have a positive coefficient on the ratio between debts to Gross Domestic Product. From the previous statistics, the United States main surpluses have always been responding in a positive manner regarding the increase in debt to GDP ratio.
One of the fears that are arising from the downgrade is that the costs of borrowing for the United States government will have to rise so that it may indemnify the private investors for their additional risk of holding the treasury bonds (Amadeo and Amadeo). This rise in the level of interest rates for the loans is a significant burden on the United States government, hence worsening the fiscal picture. There are many factors that affect the prices of bonds other than the ratings of the bond. The impact of a change in the ratings is always greater when the issuer is relatively unknown to the investors and where there is no active secondary market that is producing a constant stream of information related to the prices (Engen & Hubbard, 2005).
The United States debt crisis has been an ongoing economic issue since 2011 when the country was heading towards a debt default and this fiscal menace continued into the consequent years. In 2014, the United States had a withstanding debt that exceeded $18 trillion, which was estimated as more than the Country’s economic output as measured by the GDP (Krishnamurthy & Vissing-Jorgensen, 2008). Historically, the country experienced a debt-GDP ratio of more than 100% that was meant to pay for the Second World War. However, this has not affected the demand for the United States treasuries, hence making them remain strong from 2011 and beyond. This is because the United States debt has been considered by many to be 100% guaranteed, since it is backed by the power the country as the world’s largest economy. The status of the dollar as a world reserve currency is a facet of the power of the United States, hence allowing the United States to borrow more and sustain an assertive foreign policy (Bohn, 2008). The capital inflows that have been associated with the dollar’s reserve-currency status have made it vulnerable, thus opening the doors for the United States to sell its securities that may empower the Unites States interest rates.
The debt crisis in the United States was created by the political battle that was going on between the Republicans and Democrats who were stalemated over the strategies of curbing the increasing debts (Amadeo and Amadeo). The Democrats were blaming the Bush administration for the tax cuts that were placed on certain items and the financial crisis that happened in 2008, promoted the reduction in the tax revenues. A boost in demand would spur the country’s economy out of recession, an increase in revenue collected and an increase in the GDP (Council on Foreign Relations). The Republicans applied the supply-side economics strategy, by advocating further cuts on the taxes and investing the cuts in growing their companies.
In 2015, there have been ongoing negotiations with the Congress on whether the amount borrowed by the government should be increased or not. However, some economists predict that if the limit is not raised, the government will lack the authority to borrow funds so as to pay the bills. In this situation, the government is likely to fail in making interest payments on its debts. A default is likely to be trigged if there arises any form of missed payments (Bohn, 2008)s. In the event, financial markets will definitely sink, the United States security checks may be delayed and eventually, the country’s economy will slip into a recession and another financial crisis. Some other research indicates that, even if the United States government manages to make these interest payments, there are some fears of default may make the private investors drop their treasury bonds, hence sending the country’s borrowing rates soaring (Amadeo & Amadeo, 2015). If the government misses the payment of its acquired debts, the consequences may be felt around the entire global. Banks from around the globe and those based in the U.S use the Treasury bonds as their securities when borrowing from one another. If at any point the Treasuries would lose value and seen as risk-free, borrowing would be affected seriously and the jolt credit markets would also feel the pinch. This would spur another financial crisis like the one experience in 2008. Moreover, banking institutions usually hold most of their capital reserves in terms of Treasury bonds and if the value of these Treasuries drops as a result of a default, it will make them cut back their lending (Amadeo & Amadeo, 2015). In this case, the government should strive to reduce their levels of borrowing and pay the already existing debts to the lenders.
Domestic Pressures in the Long-term Rates
From my interview with an economist from the University of Californias, the hangover from the 2008 financial crisis is one of the factors that were weighing heavily on the prices of the Treasury bonds and increased the interest rates. Other than the tax cuts and increased spending in the past financial years, the stimulus spending and a reduction in the tax revenues resulting from the economic recession worsened the United States fiscal situation. He also adds that high demand from the Federal Reserve, which is a single source of financing, is likely to be scaled back, thus exerting an upward pressure on the long interest rates (Amadeo and Amadeo). This is evident when the Fed bought $300 billion in the long-dated treasuries to a point that the purchase put a downward pressure on the interest rates. In this case, a cessation of the Fed’s credit-easing policy may lead to an increase in the interest rates.
An increase in the inflation rates can have a great impact on the long-term nominal interest rates. The long-term expectations on inflation have been on a post-crisis has been on the rise, thus exerting an upward pressure on high-interest rates (Fleming, 2000). Concerns about the structural break in the fiscal policy may upset the expectations of the investors within the United States. The pay-go social security and the Medicare are some of the popularly known financial problems of the Federal government. Most of the concerns of the investors are likely to be reinforced by the official projection of the perpetual deficits even when under an optimistic assumption, by credit guarantees that are open ended to the debt lenders, and by the uncertainties about the fiscal ramifications of the newly implemented health care programs (Auerbach & Gale, 2011). The estimated fiscal reaction functions usually call for the primary surpluses when the debt to GDP ratio increases to a critical value of approximately 55-60 percent under the normal conditions (Voxeu.org). The official projections at that particular period assumed substantial and unending primary shortage at the debt to GDP ratios. In terms of economics, these projections can be interpreted as signs of structural breaks. Determining a shift in the investor expectation is always sudden.
The fiscal gains from the rate of inflation usually depend on the structure and ownership of the debt. In the United States, over ninety percent of the non-indexed share and approximately fifty percent of foreign ownership supports inflation, but the gains are limited by the short time limits (Blanchard, Dell’Ariccia, & Mauro, 2010). Almost thirty percent of the nominal debt that the U.S has been due within a short term of twelve months and the other remaining percentage, seventy percent, is within a duration of five years. Even though the country has seen a slight improvement in the GDP, the fears of inflation are nonetheless difficult to dismiss. Throughout history, those countries in such a crisis have debased their currencies.
The fiscal theory of the price level tends to make inflationary outcomes that are intellectually respectable. However, in this context, the theory is problematic since it handles the availability of the nominal debt as provided. When a nominal debt is outstanding, there is a higher probability that it might be inflated (Auerbach & Gale, 2011). Before the nominal bonds are issued to the private investors, the federal government is entitled to convince the buyers that the debt will definitely pay a real competitive return. In a different context, the government should be able to overcome the time consistency issues, and it is credibly achieved when there is an independent central bank and a Ricardian monetary fiscal coordination.
Quantitatively, the United States public debt is relatively small to implicit pay as you go obligation: a debt of $9.7 trillion verses a social insurance of approximately $43 trillion of closed-group liability. In this case, a credible strategy for addressing the health care and pension costs should help in calming the fears of inflation (Blanchard, Dell’Ariccia, & Mauro, 2010).
Debt Crisis Solution
The United States has been given a respite by the Global market. The policy makers may use these respites to avoid making the harsh decision and increase the rate of borrowing, hence taking advantage of the low-interest rates and high global demand for the United States bond. If the United States takes more debts, the international borrowing privilege of its currency may not last for a longer period of time (Bohn, 2008). In 2010, the Obama administration’s deficit review commission took that time as an important national opportunity to address the issue. Although some people might take this as a means of gaining political mileage, failure to act on such an issue may jeopardize the economy of the United States and the national security. In order for the country to attract more foreign capital, the United States will have to control the appetite it has in getting the loans. Furthermore, it should amend its issues while the foreign capital is still available rather than continue waiting for a crisis that will inject more pain on the issue. Fiscal adjustments are all the most urgent since some sources of the dollars Reserve Currency may not survive for long (Krishnamurthy & Vissing-Jorgensen, 2008). The Eurozone, in particular, when it holds together, it recognizes the necessity of a unified sovereign bond market. However, this newly created bond market that acts as a bailout facility may be financed partially by the Eurozone bonds and the proposals may go further. Shortly, the United States treasury market may have rivals in terms of liquidity and depth in the market (Engen & Hubbard, 2005).
For the United States to continue being the world’s reserve currency, with all the duties and perks, it should be able to provide the world with a strong currency that is not easily eroded by inflation effects and conditions, which include the transparent and deep markets that are able to convince both the foreign and domestic investors to commit their funds to them. Also, the United States should find the strategies and projects that will utile the borrowed funds effectively. Borrowing to finance a public or private consumption is not advisable, but rather one should borrow to finance the expansion of the capital stock, which is meant to improve the productive capacity of the country’s economy. If a debt is used in expanding output, the debt to GDP ratio is likely to either remain stable or even fall, even when the level of borrowing remains high. But the persistence in getting a loan from another country or the international banks should not be accompanied by persistence in the household and government consumption.
A debt crisis solution is economically simple but politically difficult. The United States government should formulate strategies that will help in cutting the government expenditure and help in raising more revenue for the government. This will stupendously reduce the deficit equally, though they possess different effects on the growth of the economy and creation of more jobs. This may restore the confidence of the investors, thus allowing the businesses to consider implementing their assumptions into the operational plans. However, the government should delay the implementation of the changes it has formulated so as to allow the economy to recover well and grow the approximately 3-4 percent required to create employment opportunities and reduce the rates of unemployment. An increase in the rate of GDP together with an increase in the revenues collected and a reduced spending rates will help in reducing the debt to GDP ratio and thus eliminating the existing debt crisis.
Council on Foreign Relations,. ‘How Dangerous Is U.S. Government Debt?’. N.p., 2015. Web. 4 Dec. 2015.
Voxeu.org,. ‘Sovereign-Debt Relief And Its Aftermath: The 1930S, The 1990S, The Future? | VOX, CEPR’S Policy Portal’. N.p., 2015. Web. 4 Dec. 2015.
Amadeo, and Kimberly Amadeo. ‘The Surprising Truth About The U.S. Debt Crisis’. About.com News & Issues. N.p., 2015. Web. 4 Dec. 2015.
Aizenman, Joshua, and Nancy Marion (2009), Using Inflation to Erode the U.S. Public Debt, NBER working Paper 15562.
Auerbach, Alan, and William Gale (2011), Tempting Fate: The Federal Budget Outlook, UC Berkeley, Mimeo.
Blanchard, Olivier, Giovanni Dell’Ariccia, and Paolo Mauro (2010), Rethinking Macroeconomic Policy, IMF Staff Position Note.
Bohn, Henning (2008), The Sustainability of Fiscal Policy in The United States, in Reinhard Neck and Jan-Egbert Sturm (eds.), Sustainability of Public Debt, MIT Press, 15-49.
Christiano, Lawrence, Martin Eichenbaum, and Sergio Rebelo (2009), When is the government spending multiplier large? NBER Working Paper no. 15394.
Engen, Eric, and Glenn Hubbard (2005), Federal Government Debts and Interest Rates, in Mark Gertler and Kenneth Rogoff (eds), NBER Macroeconomics Annual 2004, 83-160.
Krishnamurthy, Arvind, and Annette Vissing-Jorgensen (2008), The Aggregate Demand for Treasury Debt, Northwestern University, working paper.
Fleming, Michael (2000), Financial Market Implications of the Federal Debt Paydown, Brookings Papers on Economic Activity, 221-251.
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