“ The U.S. needs to pay for the structural increases in spending that demographics, climate change and intra- and intergenerational fairness will require. ”
Now that the brinkmanship over the U.S. federal debt limit has been suspended until January 1, 2025, two major, interdependent fiscal-policy challenges demand attention.
First, America’s public debt must be put on a safer, more sustainable trajectory; and second, the country’s leaders need to determine the optimal size of the public sector, as measured by primary public spending (excluding interest payments) as a share of GDP.
According to the International Monetary Fund’s April 2023 Fiscal Monitor report, U.S. general government net debt was 94.2% of GDP in 2022, compared to an average of 81.6% across advanced economies and a global average of 74.6%. While the U.S. net debt ratio was already elevated in 2019 (83.1%), it surged to 98.3% in 2020 as COVID-19, and the policy response to it, boosted the numerator and depressed the denominator. These recent figures are not only peacetime records; they also exceed the peaks at the end of World Wars I and II, when the higher ratios were rapidly eroded by (unanticipated) inflation and growth.
Fiscal policies should ensure that the net non-monetary debt of the consolidated state (including the central bank) does not exceed the present discounted value of current and future primary surpluses, including non-inflationary seigniorage. While the Federal Reserve will generate some revenues from the issuance of base money net of any interest paid on the outstanding stock of central-bank money, the seigniorage consistent with its inflation target is likely to be less than 0.5% of GDP. Not even acolytes of Modern Monetary Theory could make these numbers work.
On the bright side, since the consolidated state’s net non-monetary debt reflects the gross debt minus the fair value of all financial and real assets, it could be reduced. Many of the state’s commercial real assets (including real estate) are not accounted for at all, and poor management of other assets tends to depress their fair value. The situation thus could be improved through appropriately priced privatization or more effective asset management by a well-designed public wealth fund.
On the negative side, the state’s existing balance sheet frequently ignores the fair value of unfunded public-sector pension liabilities and other entitlement programs. More to the point, the IMF’s forecast shows the U.S. net debt-to-GDP ratio rising in each of the next six years as it approaches 110.5% in 2028. With cyclically adjusted primary balances between -4.1% and -3.4% of potential GDP, this trajectory is clearly unsustainable. The time has come either to stabilize this ratio or — preferably — to bring it down materially.
The IMF estimates the U.S. cyclically adjusted primary balance to be -4.1% of potential GDP in 2023, close to its pre-COVID value of -3.7% in 2019. Assuming that the interest rate on public debt will not be consistently lower than the growth rate of nominal GDP, the U.S. needs to achieve a fiscal tightening of at least 4% of GDP (for cyclical and debt-sustainability reasons). For its part, the U.S. Department of the Treasury argues that, “Preventing the debt-to-GDP ratio from rising over the next 75 years is estimated to require some combination of spending reductions and revenue increases that amount to 4.9% of GDP over the period.”
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