Who will feel the consequences of irresponsible federal fiscal policy?

High national debt and sustained budget deficits can have a range of significant consequences for an economy and its citizens.

Here’s a breakdown of the key impacts:

1. Higher Borrowing Costs and Interest Payments:

For the Government: As national debt grows, the government has to pay more in interest to its lenders. This means a larger portion of the national budget is allocated to debt servicing, potentially “crowding out” funding for other essential public services and investments like education, infrastructure, or research and development.

For Individuals and Businesses: Increased government borrowing can put upward pressure on interest rates across the economy. This translates to higher borrowing costs for individuals (e.g., mortgages, car loans, credit card debt) and businesses (making it more expensive to invest, expand, and create jobs).

2. Reduced Economic Growth:

Crowding Out Private Investment: When the government borrows heavily, it competes with the private sector for available capital. This can reduce the funds available for private businesses to invest, leading to slower productivity growth and, consequently, slower overall economic growth.

Stagnant Wages and Higher Prices: With less private investment, businesses may invest less in technologies and efficiencies that make goods and services cheaper to produce. This can lead to slower wage growth for workers and higher prices (inflation) for consumers, eroding purchasing power.

3. Increased Risk of Fiscal Crisis:

Loss of Investor Confidence: If national debt reaches unsustainable levels, investors (both domestic and foreign) may lose confidence in the government’s ability to repay its debts. This can lead to a demand for even higher interest rates to compensate for the perceived risk, making it even more expensive for the government to borrow.

Jeopardizing Reserve Currency Status: For countries like the United States, a loss of confidence in government debt could jeopardize the dollar’s dominance as the world’s reserve currency, with far-reaching implications for global financial markets and the U.S.’s economic standing.

Forced Austerity: In a crisis, the government might be forced to undertake sharp and painful measures, such as significant spending cuts or massive tax increases, to restore fiscal stability.

4. Reduced Fiscal Flexibility:

Limited Ability to Respond to Crises: High debt levels can limit a government’s ability to respond effectively to unforeseen crises, such as economic recessions, natural disasters, or public health emergencies. With a strained budget, there’s less “fiscal headroom” to implement stimulus measures or provide necessary relief.

5. Intergenerational Burden:

Future Tax Hikes or Inflation: Sustained deficits and growing debt essentially shift the burden onto future generations. They may face higher taxes, reduced government services, or higher inflation (which devalues their savings) as the government attempts to manage or pay down the accumulated debt.

6. Vulnerability to External Factors:

Foreign Holdings of Debt: If a significant portion of a nation’s debt is held by foreign investors, a larger share of national income and growth accrues to those living in other countries. It can also make a nation more exposed to instability in international credit markets and reduce its control over its own financial markets.

About 30% of federal debt is held by foreign investors.

It’s important to note that the immediate effects of deficits can vary. For instance, in a weak economy, increased government spending (leading to a deficit) can act as an “automatic stabilizer” by boosting demand and cushioning the economic downturn. However, persistent structural deficits, even in good economic times, are generally viewed as harmful in the long run.