How much national debt is too much?

0:00This is Planet Money from NPR.

0:06Okay, we are going to start today's show by jumping into the old Planet Money time machine. Boop, boop, boop, boop, boop, boop, boop, boop, boop, boop, boop, boop, boop, boop, economic destination 2009, a time when the government was spending lots and lots of money and the national debt was shooting up. Yeah, back then the U.S. was trying to pull itself out of the recession that followed the financial crisis. And one of the big strategies the government used was just to spend and spend and spend. We bailed out some banks. We lowered taxes. There was all this money for infrastructure. Early in the recession, I think a lot of people were very supportive of the big steps the government took to increase government spending and reduce taxes.

0:52That is Karen Dinan. She teaches at Harvard now. Earlier in her career, she worked at the Federal Reserve, did a stint as the chief economist at the Treasury Department. And Karen says it didn't take long for some people to question the wisdom of all that spending. Attitudes changed. And, you know, there were some economists and some policymakers, I think particularly people we would call deficit hawks, who started to get quite concerned. Karen, she was firmly in the deficit dove camp back then. To her, it seemed obvious that the economy was not going to get back on its feet without an ongoing infusion of government spending.

1:31but she at least understood the thing the hawks were afraid of. Sure. In pure dollar terms, at least, the country had never taken on so much debt so fast. In 2008, the gross public national debt was around$6 trillion. Then it was$7 trillion. Then$9 trillion. By 2012, it was$11 trillion. And as most econ textbooks will tell you, there can be real dangers in running up a big national debt. One of the classic worries is how much the debt you take on now could cost you in the future. So the scary thing about high debt is that you can get a snowballing of debt because of interest costs. And when you're paying a lot of interest and then you're running a larger deficit because you're paying a lot of interest, that adds to the debt.

2:20And then you get to the next period and you have more debt and then you have more interest. And so it just keeps compounding and getting worse and worse and worse. After the financial crisis, interest rates were low. But that didn't necessarily mean they would always be low. The markets could look at these higher and higher levels of debt and decide, you know what? Maybe Treasury bonds, the IOUs the U.S. government has to sell to spend more than it takes in. Maybe those bonds aren't such a great investment anymore. Debt becomes costly for us when investors, the people that buy our debt, lose their appetite to hold our debt.

2:57Right, because to keep investors buying that debt anyways, the government would then have to pay higher and higher interest rates on those IOUs, which would make the whole thing snowball even faster. Now, neither of those bad, scary outcomes came to pass. In hindsight, it actually seems pretty clear that the people saying the government was right to spend all that money, that they ended up on the right side of history. If anything, a lot of economists, including Karen, actually think that the government should have spent even more than it did, that it could have shortened the Great Recession. But that's hindsight.

3:29Yeah. Karen says it could be really tricky for policymakers to make these huge decisions in real time without knowing for sure what's going to happen as a result. You can't just look in the textbook to get the answer to your policy challenge that you're facing. You don't have evidence to go off of. And it leads to this murkiness. Which leads us to now, to 2024. Because once again, we have lived through a massive crisis, this time the pandemic. And once again, the government responded to that crisis by just pumping incomprehensible amounts of money into the economy. And running up a huge tab. In 2019, the gross public national debt was around$17 trillion.

4:12Today, it's over$26 trillion. And where after the financial crisis, Karen looked at the situation and said, you know what? It's worth the risk. We got to keep spending. This time, she is not so sure. Because she thinks at some point we could get to a place where there is too much debt. And it does start to hurt the economy. But it's not clear to her where that line is. The uncertainty, the lack of evidence, the murkiness, that's feeling pretty real for her these days. I mean, so the image that comes to mind is that the policymaker, I imagine sort of like inching out on the ice. And then if it cracks, that's when you stop and you hope you don't fall through.

4:52I think that's right. I mean, I think that's the, I mean, the ice cracking, that's when you're in real trouble. But when exactly that ice might crack? When the debt will start to hurt the economy? We can't really say. It seems like we don't have a good way of knowing whether we're 5 % away from the ice cracking or 50 % away from the ice cracking. Yeah, that's a problem. That is a real problem. Hello and welcome to Planet Money. I'm Keith Romer and I'm Nick Fountain. The idea that a lot of national debt is bad for the economy has been around for a long time. But nailing down when exactly the bad thing is supposed to happen, economists have not been able to do that.

5:38So today on the show, a deep dive on what we know and what we don't know about when a lot of debt turns into too much debt. Economists have been thinking about this and fighting about it for a long time now. We're going to take a look at some of that thinking and some of that fighting. and we are going to try to figure out just how big a problem our$26 trillion worth of national debt really is.

6:12When economists talk about the trouble that a country can get itself in by running up too much debt, there are a few bad scenarios they worry about. One of them is that the country can end up so underwater that it ends up defaulting on its debt, stiffing its creditors, which tends to not go great. Sure. Or in order to escape its debt, maybe a country has to let inflation run wild and make its money worthless. Also not great. But things can also get bad without getting quite so dramatic. Sometimes having a lot of debt can just drag down the economy, chop growth off at the knees. And this last concern was really what the fight was over in the U.S.

6:50in the aftermath of the financial crisis. Was all this money the country was spending ultimately going to end up causing more problems than it solved? That relationship between national debt and slow growth also just so happened to be the subject of this famous paper that came out in 2010, right as U.S. debt was really taking off. The paper's authors were these two prominent economists, Carmen Reinhart and Kenneth Rogoff. They dug up all this data about debt for 20 advanced economies across decades. And according to the paper, history had a thing or two to teach us about what levels of debt were okay and which levels maybe weren't okay.

7:29The paper was short. It was just six pages. It was called Growth in a Time of Debt. And it kind of took the world by storm. In a lot of ways, it defined the terms of the argument for the next several years. In fact, this little paper had such a big impact that we are going to spend most of the rest of the show talking about it. The ideas it inspired and also the fights. Karen Dinan, the Harvard professor from before, says the paper was such a big deal, in part because it seemed to offer an answer to that giant question on everyone's mind back then. At what point will the debt start to limit economic growth?

8:03The statistic that caught so much attention was that they had a result that suggested that when a country has debt that is equivalent to 90 percent of their GDP, that their growth rate would be half of what it would be in times when debt was at a more normal level. So just for a little context, in the early 2000s, the debt-to-GDP ratio in the U.S. was around 35%, meaning the national debt was equivalent to 35 % of the value of every good or service the country made for an entire year. By 2010, when the paper came out, the debt-to-GDP ratio had gone all the way up to 60%. So not anywhere near that 90 % line, but getting closer.

8:50And sometimes when Reinhardt and Rogoff would write about their findings, they would use a national debt figure that included treasury bonds the government held itself, which made the U.S. debt-to-GDP ratio look like it had already crossed 90%. And so you can kind of see why so many politicians and people in the media latched on to that paper. You know, here was this speed limit for debt that said, if your debt goes past 90 % of GDP, then the wheels are going to fall off of your economy. Even though we should say that is not exactly what the paper said. The claim was more, hey, here's this interesting pattern in the data that suggests that high debt is, generally speaking, worse for economic growth than having lower levels of debt.

9:37But, Karen says, that 90 percent number, it got some real traction. You know, it wasn't your average economist who was running around like things were on fire. It was more that the people who didn't like all this fiscal stimulus were starting to use it as a reason why the government needed to tighten its belt. If you were a debt hawk, you had a good argument for your position. Yeah, exactly. Now, up to this point, we've been talking about this grand debt experiment as if the U.S. were the only country that was running up this huge bill. But, of course, lots of countries were trying to spend their way out of the Great Recession.

10:13Debt-to-GDP ratios were ballooning pretty much everywhere. And so around the world, people were looking at that 90 percent red line and wondering, um, does that apply to us, too? Back then, International Monetary Fund economist Andrea Presbitero was just getting started in macroeconomics. economics. At the time, I was an assistant professor at the university in Italy. Which university? University of Ancona, which is a small place in the east coast of Italy by the sea. As much as the paper itself, Andrea remembers the bites about it, playing out in blogs and newspapers. I think when that paper came out, it was a big deal, meaning it was clearly an important paper on a very important topic, very sensitive topic at the time.

10:55Yeah, these were live arguments. There were impassioned calls for austerity measures and belt tightening, and equally impassioned arguments for the other side, saying, no, don't mess up this recovery. Now is not the time to stop spending. The paper even generated a kind of mini scandal at one point. These, shall we say, more debt-friendly economists put out a paper highlighting a pretty big mistake in the Excel spreadsheet that Reinhart and Rogoff had used. The last sentence of that That paper reads, the fact that Reinhardt and Rogoff's findings are wrong should therefore lead us to reassess the austerity agenda itself in both Europe and the United States.

11:32So that was also added sort of to the debate. It was not just a debate and the one who were saying, oh, yes, this is a good argument to push for fiscal consolidation. Others saying maybe not. There was also a discussion about, yes, this is basically evidence which is flawed and based on some mistakes. And so that makes, I guess, the debate even more sort of strong between people. Correcting the mistake in the paper weakened the effect that high debt seemed to have on growth. But it didn't make it go away. And Andrea says a lot of economists were still intrigued enough to want to keep poking and prodding at that seductive idea of the magic debt threshold.

12:12I think that the true contribution of this paper by Reinhard and Rogoff was to open up a very large body of research that started from their funding and try to dig deeper and try to expand our understanding of how that could affect the economy. Because there were some really fundamental questions that that Reinhard and Rogoff paper had left unanswered. Yeah, like here is one very, very important question. Just because there's this correlation between high levels of debt and lower growth, does that necessarily mean that high debt is causing the economy to slow down? And I guess that correlation is not causation.

12:54It's a sentence that in Planet Banner has been repeated like a zillions of time already. It's basically our motto. Yeah, yeah. We have it in Latin written over the door. Exactly. So clearly, also in this case, correlation doesn't mean causation. Now, there are good theoretical reasons for why you might think that too much debt could slow down the economy. We've talked about a couple of them already, the snowball effect of all that debt compounding, the way investors can demand higher returns on government bonds. There's also this phenomenon that economists call crowding out, which works like this.

13:27To take on debt, the government has to sell treasury bonds, basically IOUs. And if investors keep buying and buying and buying those treasury bonds, that means that money isn't going into private investment. You know, building factories or researching the next generation of microchips. And so growth, the idea goes, is going to suffer. But Andrea says that causation here could also run in the opposite direction. Low growth could be causing high debt. You can really think a situation in which your economy is underperforming and you as a policymaker, you want to stimulate the economy. Therefore, you want to do public consumption, public investment.

14:07And one way to do that is borrowing money. If you're borrowing money, you're going to increase your debt. So what you're going to observe in the data, you have low growth and high debt. And exactly because of this example, really we cannot conclude that higher debt is causing lower growth. If anything, it's the other way around. The causality question is one that Andrea worked on himself. In the end, he and his co-author concluded what pretty much everyone ended up concluding. Based on the empirical evidence, at least, you can't definitively answer this one. Andrea thinks that depending on the situation, the causation can run in either direction.

14:44Sometimes high debt causes low growth. Sometimes low growth causes high debt. Andrea and all these different economists around the world also looked into other questions, other ways of looking at the historical data that could help identify when exactly debt might become dangerous. This sort of tipping point, if you want, is going to be potentially very different across countries. So it could be 90 percent for some economies. It could be 45 percent for other economies. It could be 100 percent for some other economies. Also, the debt a country has, that can come in all of these different flavors.

15:19There are many dimensions in which debt is going to be different. One, for instance, is the currency composition. One country can borrow in domestic currency, and another country could have to borrow much more in foreign currency. So sort of the Argentina problem. Yes. Let's think of an emerging market like Argentina or any other country who borrows in dollars. when the currency depreciate, then the value, the dollar value of your debt, it become higher. So you need much more money to pay back the debt. Also, it seemed to matter who held the government's debt. Was it banks? Was it investors from inside the country?

15:52From outside the country? Was it short-term debt? Long-term debt? Yeah, how much debt a country can safely take on turns out to depend on all these different factors. This is one where the simple seeming result, you know, countries that have debt-to-GDP ratios over 90 % see lower economic growth, where that result just got more and more and more complicated the longer people poked at it. Which Andrea sees as a good outcome. Economists, they know more now than they did when all of this started. Even if you don't get to perfection, even if you do something to the extent that you are aware of limitation of your analysis, I think you still provide a very valuable contribution.

16:33But here's the thing. After several years of this kind of scholarship, the attention of macroeconomics kind of drifted away from the topic. In part, this was because of how fractured the problem had become, how many tiny pieces that one big, clean-seeming idea had turned out to have been made of. But it was also because the real world itself suddenly seemed to be saying, eh, maybe this isn't such a big, important problem after all. because the thing that makes high levels of debt destructive to an economy is not really the debt itself. It's the interest a country has to pay on that debt. And in the wake of the financial crisis all around the world, interest rates went down to basically zero and just kind of stayed there for years.

17:20And so for a while, a lot of macroeconomists were like, maybe we don't really need to worry all that much about debt after all. And then the world changed again. Again, in two ways. First, the pandemic and all the spending that followed pushed debt way higher. And second, and more importantly in this case, interest rates went back up. And so having a lot of debt today is going to cost the U.S. and countries all over the world a lot more than it would have five or six years ago. Yeah, that question that economists put down for a bit, how much debt we can get away with, it is starting to look pretty relevant again.

18:00After the break, how dangerous is our$26 trillion of national debt? We put that question to the OG of debt-to-GDP ratio-ese. It's Kenneth Rogoff. We're talking to Kenneth Rogoff. Yes.

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19:07So I will start you off with the easiest question, which is, can you identify yourself? Yeah, my name is Kenneth Rogoff. I'm a professor of economics at Harvard University. And I realize you've reminded me of one of my other questions, which is Kenneth or Ken. Oh, Ken is great. Okay, so we'll go Ken. I mean, but when I'm giving my formal name, Kenneth. Formally Kenneth, informally Ken. Yeah. If you ask Ken Rogoff about that paper he wrote with Carmen Reinhardt, it is clear that 14 years on, he is still kind of annoyed about the way it all blew up. Back then, Reinhardt and Rogoff were writing op-eds warning governments of the risks of debt levels above 90%.

19:48But today, he insists he never meant for people to take their groupings of countries into low debt, medium debt, high debt, and very high debt to GDP countries to mean that there was some bright red deadline you couldn't cross. One of our buckets was, it was our highest bucket, was 90%. But we didn't say that suddenly you go to the devil when you get to 91%. That's a little bit like saying if you're driving in a car in a 55-mile-an-hour speed limit and you go to 56, you're going to crash the next minute. And that interpretation, which was polemically used in addition to a lot of polemic misrepresentation, I think said, oh, it's so crazy.

20:32How can they say that? And, of course, we didn't. And he says, yes, obviously there are a lot of factors that contribute to when national debt becomes a problem for a country. And, of course, different countries are going to be able to tolerate more or less debt. But I do want to qualify that a little bit by saying to say, therefore, there's no threshold. Therefore, any level of debt is fine. That's kind of nuts also. Yeah, his basic intuition remains unchanged. He says a country is playing with fire if it just loads on more and more and more debt. Eventually, all of that debt is going to slow down the country's ability to grow.

21:10And he thinks the U.S. is headed in that direction right now. I think if you look at where the United States is today, we're probably on a trajectory that needs to get adjusted. And it's not just our debt, it's our Social Security, our medical care, everything. But Ken says politicians on both sides of the aisle have gotten really resistant to either raising taxes or cutting spending enough to balance the budget. Ever since the pandemic started, the U.S. has been running enormous budget deficits. In 2020, it was over 14 percent of GDP. But even last year, it was 6 percent. The tendency is when the other party's in power, debt's a terrible problem.

21:49And when you're in power, it's not. According to the Congressional Budget Office, the debt-to-GDP ratio in the U.S. is on track to pass 115 percent in 2033. And get to 180 percent sometime in the next 30 years. When Ken looks at all this, it's not like he thinks we are headed towards some economic Armageddon. You know, barring something really horrible happening, I don't foresee a massive problem. But Ken says there are signs of trouble in the economy. We've seen inflation spike, investors demanding higher rates on U.S. Treasuries. To him, those happen partly as a result of all the debt we've taken on.

22:35And he thinks spikes in inflation and interest rates might keep happening. What I think is likely to happen over the next 10 years is we'll probably have another episode of that. So maybe until we've got punched in the face a couple more times, we may not adjust. and adjusting, finding a way to stop running such a high deficit year after year, that would involve some genuinely hard trade-offs. Some mixture of cutting into how much we spend on programs that Americans really value or raising taxes pretty significantly. Now, Ken, he has been on the more debt hawkish side of things for a long time now.

23:16But even some of those economists who used to feel okay about how high the debt was getting, They are starting to see things differently. Like Karen Dinan, the other Harvard professor we talked to at the start of the show. After the Great Recession, she thought all the spending we were doing was worth the risk. This time around, she's not so sure. Policymakers need to be honest about what's on the horizon in terms of national debt and the fact that we are on an unsustainable path. my sense is that you did not used to worry about the size of the national debt to the extent that you do today and i wondered is it are you a are you maybe a born again debt hawk karen was not willing to go on the record as team hawk but it was actually this stray kind of hawkish comment I heard her make at a conference earlier this year that inspired this whole episode.

24:20She had been talking about all the stuff we've been talking about in the show, how big the debt is, how higher deficits have been. And she said something to the effect of, you know what? I know there's no magic red line for debt, but maybe we'd all be better off if there was one. Having a benchmark like that is useful because it can force action. and even though I don't think there is a magic level I do feel like if if there was some some level we knew about it could then kind of be constructive politically and get people to face up to the hard decisions they're going to need to make like you kind of wish there was one yeah Yeah.

25:04Yeah.

25:08So you don't want me to ask you at what percentage of GDP the national debt will cause a crisis? No, I mean, I can't tell you that number. Is it 125 % of GDP? You're still asking me. Higher or lower? Sorry, I'm not answering that question.