Can the U.S. Grow Its Way Out of the National Debt?

In April 2020, the size of the U.S. government’s total public debt outstanding as measured against the country’s GDP spiked up to 135% in the wake of government-mandated pandemic lockdowns. That’s the highest the U.S. national debt-to-GDP ratio has ever been, breaking the previous record of 121% set in the World War II era.

121% is about where the U.S. total national debt-to-GDP ratio is today. It’s been hovering around that level since July 2021. After initially falling rapidly after the economy was allowed to reopen in 2020, progress in lowering the national debt burden has stalled. This stagnation has occurred even though the nation’s GDP has risen.

That contradicts the experience of what happened to the national debt-to-GDP ratio after World War II. It has long been held that this ratio fell rapidly because of strong economic growth. But a new working paper by Julien Acalin and Laurence M. Ball challenges that explanation. Here’s what they found when looking at just the publicly held portion of the national debt in their study:

The fall in the U.S. public debt/GDP ratio from 106% in 1946 to 23% in 1974 is often attributed to high rates of economic growth. This paper examines the roles of three other factors: primary budget surpluses, surprise inflation, and pegged interest rates before the Fed-Treasury Accord of 1951. Our central result is a simulation of the path that the debt/GDP ratio would have followed with primary budget balance and without the distortions in real interest rates caused by surprise inflation and the pre-Accord peg. In this counterfactual, debt/GDP declines only to 74% in 1974, not 23% as in actual history. Moreover, the ratio starts rising again in 1980 and in 2022 it is 84%. These findings imply that, over the last 76 years, only a small amount of debt reduction has been achieved through growth rates that exceed undistorted interest rates.

Their findings suggest U.S. policymakers cannot count on economic growth to bring the national debt-to-GDP ratio down to more manageable levels. Worse, their analysis of how the government’s debt-to-GDP ratio was successfully reduced after World War II indicates the government is on the wrong fiscal path today:

As of the end of fiscal year 2022, the actual debt/GDP ratio has risen to 97%, close to its peak of 106% in 1946. If history is a guide, economic growth will probably not be enough to resolve this problem. Will the debt/GDP ratio be reduced some other way?

It is unlikely that the interest-rate distortions that reduced the ratio after World War II will occur again. Presumably, U.S. policymakers are not considering the kind of interest-rate peg (with price controls to contain the inflationary effects) that was imposed during World War II. And despite the recent surge in inflation, the Federal Reserve appears committed to pushing inflation back down and keeping it low, which would preclude debt erosion through surprise inflation. Additionally, any inflation surprises that occur will have smaller effects than they did in the past because the average maturity of the debt is shorter (Aizenman and Marion 2011, Hilscher et al. 2021).

The upshot is that reducing the debt/GDP ratio substantially will probably require primary budget surpluses. Yet surpluses also appear unlikely: Under current policy, the Congressional Budget Office predicts large primary deficits over the next three decades. Absent a major shift toward fiscal consolidation, these deficits are likely to push the debt/GDP ratio to higher and higher levels.

By fiscal consolidation, Alcalin and Ball mean putting the federal government onto a sustainable fiscal path. Such a sustainable fiscal path would, at a minimum, limit government spending to grow at a slower rate than the growth of its revenue. We already know our economic growth since the middle of 2021 will not do the job by itself.