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Can We Afford the National Debt? Thumbnail

Can We Afford the National Debt?

The U.S. federal debt has risen steadily since the 2008 Great Recession. The COVID-19 pandemic increased government borrowing even further. 

As the chart below shows, the federal debt was 127 percent of our national income in early-2021.

Governments tend to borrow and spend more during times of economic uncertainty. This increased spending aims to replace the "slack" created when personal spending temporarily declines during these same periods.

The national debt clock (usdebtclock.org) highlights this borrowing and spending in a fantastical format.

Taking on debt can be playing with fire

In our daily lives, we all make decisions regarding what we can afford. The "affordability" of debt is no different.

While it might be right for you to have zero debt, economists describe the "right" amount of debt as a relationship between income and the cost to borrow. 

  1. Income: The more you earn, the lower the burden of debt and the more you can afford to borrow. Keep in mind that your total level of income matters just as much as any changes to your level of income. 
  2. Cost: The lower the cost of borrowing (as measured by the debt's interest rate), the lower the burden of debt and the more you can afford to borrow. 

To calculate the "affordability" of debt, compare the percentage growth rate (or decline) of income to the percentage cost of borrowing. 

To illustrate the affordability of U.S. federal debt, the graph below plots the cost of servicing U.S. federal debt. When our national income grows more quickly than our borrowing rate, then the cost of servicing debt is viewed as affordable. Often the cost is so low that it might be considered free (after inflation)!

"The graph presents an interesting picture. In the years since the [2008] Great Recession, the cost of servicing public debt has been negative, which means that the burden of U.S. public debt is low."1

"Since 1960, negative debt servicing costs have occurred nearly 63 percent of the time; and the average cost of servicing debt is -0.67%. In fact, since the 1960s, the only time period in which the real interest rate was consistently greater than the growth rate of real GDP [income] was from 1981 to 1995." 1

Interest rates have been low since the 2008 recession, but expectations are of an upward trajectory, which may increase the cost of servicing the federal debt.

Household debt is at all-time lows

While it seems as if the U.S. government is constantly borrowing more and more, households tell a different story.

Household net worth in this country spiked in the first quarter of 2021—to $136.9 trillion—propelled by broad gains in the stock market and in home prices. How frequently do you hear this mentioned? Household debt, at $16.9 trillion, is an attention-grabbing headline, but it pales in comparison to the value of household assets at $153.8 trillion. 

Even more important, perhaps, is the fact that the ratio of household debt to assets continued to fall, and is now back down where it was 50 years ago. 

As the chart below shows, the cost of servicing household debt, as a percentage of income, is below where it was in the '80s.

Households have rarely carried more manageable debt levels relative to income and have simply never been holding more cash than today.

Fortunately, households power our economy, not the government.

While government borrowing and spending can appear unaccountable, households appear to have taken a more reliable path. 

  1. https://fredblog.stlouisfed.org/2018/11/how-expensive-is-it-to-service-the-national-debt/