Question

In your opinion is the US debt a problem for the United States or not? Given that monetary policy has an effect on interest rates, should monetary policy work with fiscal policy to reduce the impacts of debt? What are the pros and cons of monetary policy and fiscal policy working together? (Answer question based on the article below)

Article:

As Congress allocates trillions of dollars to support businesses and individuals impacted by the coronavirus pandemic, some project US debt skyrocketing to historical highs. This adds fuel to a long-running question: Does America’s growing debt load spell future trouble? In our view, focusing solely on the debt’s size doesn’t tell the whole story. By looking at the debt question differently, we think investors can defuse concerns about America’s allegedly ticking time bomb.

Even before the coronavirus dominated headlines, some worried about big deficits adding to America’s debt. In early May, US Treasury data show $25.1 trillion in total federal government debt outstanding. [i] While this figure includes intra-governmental holdings (i.e., money the government owes itself), even stripping this away leaves net public debt at a still-huge $19.1 trillion—nearly 2.5 times the amount on January 1, 2010. [ii]

In isolation, that big number doesn’t mean much. So to put this figure into perspective, many economists compare a country’s debt to its GDP. At the end of 2019, net public debt was 79.2% of US GDP—up from 52.3% a decade earlier and the biggest since the late 1940s. [iii] Moreover, coronavirus’ impact is almost assured to push the ratio far higher. Between Q1’s -4.8% annualized GDP decline (with worse likely in Q2) and rising debt as the government funds its coronavirus response, America’s debt-to-GDP ratio could exceed its post–World War II high of 106.1% in the not-so-distant future. [iv]

Large debt-to-GDP ratios inspire comparisons to countries like Greece, which defaulted multiple times in the past decade. But even these ratios alone don’t mean problems loom. What matters more: a country’s ability to meet interest payments. Governments don’t use GDP—an annual flow of economic activity—to meet those obligations. They use tax revenue. In fiscal year 2019, US interest payments accounted for about 10.8% of tax revenues. [v] This figure has been rising over the past 4 years, but it remains well below the 15%–18% range in effect during most of the 1980s–1990s. [vi] America had no trouble servicing its debt during these two decades. The economy boomed.

With Treasury yields historically low, many acknowledge financing debt today isn’t onerous—especially since the Treasury gets to refinance maturing debt at a cheaper rate. On May 5, 2010, the Treasury sold $24 billion in 10-year notes at a 3.51% interest rate. [vii] The Treasury effectively refinanced those at a mid-May 2020 auction of new 10-year notes. The interest rate? A far-lower 0.65%. [viii]

Which brings us to another point: Treasury bonds carry fixed rates, so rising rates don’t immediately threaten affordability. As of 12/31/2019, the weighted average maturity of US debt was nearly 70 months—higher than the 60-month historical average over the past 40 years. [ix] Hence, rates would need to rise significantly from here—and stay there for years as Treasury refinanced maturing bonds—to hit costs materially. That doesn’t seem likely today. Demand is strong, putting downward pressure on yields. With sovereign-debt yields low globally—Japan and Europe have lower rates than America—US debt remains more attractive in comparison.

Moreover, interest rates tend to move with inflation, and the latter looks unlikely to surge in the near future. Even after the spread widened between long and short rates since February’s end, the US yield curve is still around its flattest over the past 10 years. That weighs on bank lending and, relatedly, money supply growth—a key inflation component. When investors anticipate higher inflation to come, they will demand a higher premium to compensate for their loss in purchasing power. That isn’t likely to be the case with inflation benign. US debt could be on its way to making new records, but that doesn’t mean new problems will come with it.

Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.

Answer 1

US government debt is not a big problem as interest rates are practically zero levels for next two years helping the government refinance their debt obligations and raising money through stake sale. Moreover, rising debt is owed due to government spending which boosts consumption and aggregate demand and thus real GDP rises makung the debt look sustainable.

Monetary policy thus should be aligned with fiscal policy to get desired effects on inflation, real GDP and business sentiment. This helps achieve larger stability in all macroeconomic indicators when both government and Federal reserve are on same page.

However it dies have disadvantages like polarised results like hyperinflation or recession when expansionary and contractionary fiscal /monetary policies are adopted simultaneously. Also it can lead to implementation lags which causes.

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