Question

What effect does deficit borrowing have on long term growth?

Answer 1

Deficits Reduce expenditures and savings. If big deficits are incurred by the federal government, it reduces national revenue, and thus also investments. Today, the result is more consumption, and slower economic growth and lower potential incomes. Particularly in a globalized economy, this happens when capital is free to shift to its most efficient usage.

Higher interest costs change other priorities and out of control will spiral. As noted, high and increasing interest payments on federal debt will make it harder for elected officials to commit resources to the required public investments that will stimulate potential growth. In turn, high interest rates would also crowd out investments aimed at improving low- and moderate-income household consumption.

The federal government will respond from time to time to unpredictable situations, such as foreign conflicts and natural disasters. Furthermore, when things like the financial crisis arise, the public turns to the federal government to boost the economy. The more the federal government borrows and spends in good times, as they are now, the less space it will have to borrow and spend in poor times, as they will undoubtedly be at some point. If the government is already overextended when an unforeseen crisis occurs, the solution may be less efficient and successful than addressing the problem appropriately.

The US is the richest country in the world, but that doesn't mean that the federal government is completely resistant to a debt crisis. As deficits and debt continue to rise, the likelihood of investors potentially seeking a much higher premium to buy U.S. treasury securities rises. If that were to happen, interest rates on the debt would increase, and political leaders could be forced to take drastic and aggressive steps to slash benefits and raise taxes to minimize deficits and restore confidence among creditors in the government's ability to fulfill its obligations. Despite the scale and prosperity of the US economy, this is not a possible scenario.