How does a high national debt affect the economy?
However, if we do nothing, the converse is also true. Our economic environment will deteriorate if our long-term fiscal challenges are not addressed, as confidence will erode, access to capital will be limited, interest costs will crowd out key investments in our future, growth conditions will deteriorate, and our country will be at greater risk of economic crisis. Our future economy will be harmed if our long-term fiscal imbalance is not addressed, with fewer economic possibilities for individuals and families and less budgetary flexibility to respond to future crises.
Public investment is being reduced. As the federal debt grows, the government will devote a larger portion of its budget to interest payments, squeezing out public investments. Under existing law, interest expenses are expected to total $5.4 trillion over the next ten years, according to the Congressional Budget Office (CBO). The United States currently spends more over $900 million each day on interest payments.
As more federal funds are diverted to interest payments, fewer resources will be available to invest in areas critical to economic growth. Although interest rates are now low to aid the economy’s recovery from the pandemic, this condition will not persist indefinitely. The federal government’s borrowing expenses will skyrocket as interest rates climb. Interest payments are expected to be the highest federal spending item in 30 years, according to the CBO “More than three times what the federal government has spent on R&D, non-defense infrastructure, and education combined in the past.
Private investment is down. Because federal borrowing competes for cash in the nation’s capital markets, interest rates rise and new investment in company equipment and structures is stifled. Entrepreneurs confront greater capital costs, which could stifle innovation and hinder the development of new innovations that could enhance our lives. Investors may come to distrust the government’s ability to repay debt at some point, causing interest rates to rise even higher, increasing the cost of borrowing for businesses and people. Lower confidence and investment would limit the rise of American workers’ productivity and salaries over time.
Americans have less economic opportunities. Growing debt has a direct impact on everyone’s economic chances in the United States. Workers would have less to use in their occupations if large levels of debt force out private investments in capital goods, resulting in poorer productivity and, as a result, lower earnings. Reduced federal borrowing, on the other hand, would mitigate these effects; according to the CBO, income per person might grow by as much as $6,300 by 2050 if our debt was reduced to 79 percent of the economy by that year.
Furthermore, excessive debt levels will have an impact on many other elements of the economy in the future. Higher interest rates, for example, as a result of increasing federal borrowing, would make it more difficult for families to purchase homes, finance vehicle payments, or pay for college. Workers would lack the skills to keep up with the demands of an increasingly technology-based, global economy if there were fewer education and training possibilities as a result of decreasing investment. Lack of support for R&D would make it more difficult for American enterprises to stay on the cutting edge of innovation, and would stifle wage growth in the US. Furthermore, slower economic development would exacerbate our budgetary woes, as lower earnings result in reduced tax collections, further destabilizing the government budget. Budget cuts would put even more strain on vital safety net programs, jeopardizing help for those who need it the most.
There is a greater chance of a fiscal crisis. Interest rates on government borrowing could climb if investors lose faith in the country’s fiscal position, as greater yields are sought to buy such instruments. A rapid increase in Treasury rates could lead to higher inflation, reducing the value of outstanding government securities and resulting in losses for holders of those securities, such as mutual funds, pension funds, insurance companies, and banks, further destabilizing the US economy and eroding international confidence in the US currency.
National Security Challenges Our budgetary stability is intertwined with our national security and ability to retain a global leadership position. As former Chairman of the Joint Chiefs of Staff Admiral Mullen put it: “Our debt is the most serious danger to our national security.” As the national debt grows, we are not only increasingly reliant on creditors throughout the world, but we also have fewer resources to invest in domestic strength.
The Safety Net is in jeopardy. The safety net and the most vulnerable in our society are jeopardized by America’s huge debt. Those critical programs, as well as the people who need them the most, are jeopardized if our government lacks the resources and stability of a sustainable budget.
Why is national debt good?
The public national debt of the United States is good since it leverages economic growth and represents the country’s excellent creditworthiness. The cost of debt payment, interest on Treasurys, is revenue for the holders: millions of seniors, mutual and pension funds, and state and local governments.
Does national debt cause inflation?
The vast majority of the federal government’s current debt is fixed in nominal terms. Only roughly 7.5 percent of the debt had been issued as inflation-linked bonds as of 2021. The longer the debt has been outstanding, the more it has been influenced by inflation.
What are the effects of public debt?
The net effect of government borrowing is said to be expansionary. Scarce resources can be dispersed rationally if loans are raised for productive uses. To put it another way, resource allocation will be based on national interests. As a result, national income will increase.
However, if loans are collected to fund non-productive activities such as debt repayment, resources may not be allocated optimally. Even yet, the impact of government borrowing on consumer spending is likely to be minimal. Public borrowing, once again, has no discernible negative impact on investment. As a result, government borrowing can have a positive multiplier effect on national income.
To fund its loan payback scheme, the government frequently charges taxes. High tax rates deter people from working more. Despite the fact that public borrowing entails a transfer of resources (from taxpayers to lenders), the negative effect of taxes (i.e., the incentive to labor less when taxes are raised) has a negative impact on revenue.
The current generation receives less capital as a result of debt. As a result, public borrowing is not always expansionary. A reduced capital stock reduces an economy’s production and productivity.
What happens if United States defaults on debt?
The government will be unable to borrow extra funds to meet its obligations, including interest payments to bondholders, unless Congress suspends or raises the debt ceiling. That would very certainly result in a default.
Investors who own U.S. debt, such as pension funds and banks, may go bankrupt. Hundreds of millions of Americans and hundreds of businesses that rely on government assistance might be harmed. The value of the dollar may plummet, and the US economy would almost certainly slip back into recession.
And that’s only the beginning. The dollar’s unique status as the world’s primary “unit of account,” implying that it is widely used in global finance and trade, could be jeopardized. Americans would be unable to sustain their current standard of living without this position.
A US default would trigger a chain of events, including a sinking dollar and rising inflation, that, in my opinion, would lead to the dollar’s demise as a global unit of account.
All of this would make it far more difficult for the United States to afford all of the goods it buys from other countries, lowering Americans’ living standards.
What country has the most debt?
What countries have the world’s largest debt? The top 10 countries with the largest national debt are listed below:
With a population of 127,185,332, Japan holds the world’s biggest national debt, accounting for 234.18 percent of GDP, followed by Greece (181.78 percent). The national debt of Japan is presently $1,028 trillion ($9.087 trillion USD). After Japan’s stock market plummeted, the government bailed out banks and insurance businesses by providing low-interest loans. After a period of time, banking institutions had to be consolidated and nationalized, and other fiscal stimulus measures were implemented to help the faltering economy get back on track. Unfortunately, these initiatives resulted in a massive increase in Japan’s debt.
The national debt of China now stands at 54.44 percent of GDP, up from 41.54 percent in 2014. China’s national debt currently stands at more than 38 trillion yuan ($5 trillion USD). According to a 2015 assessment by the International Monetary Fund, China’s debt is comparatively modest, and many economists have rejected concerns about the debt’s size, both overall and in relation to China’s GDP. With a population of 1,415,045,928 people, China currently possesses the world’s greatest economy and population.
At 19.48 percent of GDP, Russia has one of the lowest debt ratios in the world. Russia is the world’s tenth least indebted country. The overall debt of Russia is currently about 14 billion y ($216 billion USD). The majority of Russia’s external debt is held by private companies.
The national debt of Canada is currently 83.81 percent of GDP. The national debt of Canada is presently over $1.2 trillion CAD ($925 billion USD). Following the 1990s, Canada’s debt decreased gradually until 2010, when it began to rise again.
Germany’s debt to GDP ratio is at 59.81 percent. The entire debt of Germany is estimated to be around 2.291 trillion ($2.527 trillion USD). Germany has the largest economy in Europe.
What happens if a country Cannot pay its debt?
The federal government of the United States is rated AAA by the majority of credit rating agencies, the highest possible rating. If the debt is not paid, the country’s credit rating will be automatically downgraded, raising interest rates for all Americans. As private lenders are obliged to raise their interest rates, small business loans will become more expensive. Even SBA-guaranteed loans, which are generally less expensive and easier to obtain but still reflect market conditions, will grow more expensive.
How can the US pay off its debt?
The debt ceiling is a limit on how much money the government of the United States can borrow to pay its debts. Every year, Congress passes a budget that includes government expenditure on infrastructure, social security programs, and federal employee wages. To pay for all of this spending, Congress levies taxes on the general public.
What happens if a country has too much debt?
Economists are looking at what level of debt is sustainable for an economy and how much is too much as part of their work on vulnerability indicators. Borrowing money from other countries can help countries grow faster by funding productive investment and cushioning the impact of economic downturns. A debt crisis can occur if a country or government accumulates debt beyond its ability to service it, with potentially large economic and social implications. As a result, determining how much debt an economy or government can safely handle is critical. This assessment is especially important for developing market economies, which rely significantly on global capital markets to fund their substantial financing requirements.
What is debt sustainability, exactly? It is a circumstance in which a borrower is expected to continue fulfilling its debts without making an excessively big future adjustment to its income and expenditure balance. Debt, on the other hand, becomes unsustainable when it grows faster than the borrower’s ability to service it. To determine how much debt is sustainable, you must consider how existing liabilities are projected to evolve over time, as well as projections regarding future interest rates, currency rates, and income trends. This, like any judgment that requires future assumptions, is tough to get right.
- developing an opinion on how outstanding liabilities will evolve over time in relation to the economy’s (or government’s) ability to pay;
- determining whether the outcomes may result in an unsustainable scenario, as indicated above
The first step is forecasting revenue and expenditure flows, including debt payment costs, as well as major macroeconomic variables including interest rates, economic growth rates, and exchange rate fluctuations (given the currency denomination of the debt). To the extent that government policies influence these factors, debt dynamics estimates are dependent on policy variables as well as macroeconomic and financial market developments, which are inherently uncertain.
Given the uncertainty, it is critical to investigate the risks as a second step. Among the most significant are greater financing costs, which may reflect global financial market developmentsincluding probable spillover effects from other troubled countriesor funding challenges specific to the country in question. Similarly, a fast exchange rate depreciation, possiblybut not necessarilyfollowing the collapse of an exchange rate peg, can dramatically increase the burden of debt denominated in foreign currencies. Indeed, as some recent situations have demonstrated, once a crisis has erupted, the size of capital withdrawals can result in exchange rate revisions considerably in excess of any original predictions of overvaluation, as happened in Indonesia during the 1997-98 crisis.
Contingent claims, such as those linked with either explicit or implicit guarantees of debt or bank deposits, are another key source of uncertainty around debt and debt service predictions. Many contingent claims go overlooked in normal times, but they are more likely to be used in times of crisis. Such assertions have been a recurring theme in recent developing market crises, where defaults in one industry impacted others. However, contingent claims are notoriously difficult to value in practice, partly because the amounts at stake are frequently unknown, and partly because the conditions of the claimsthe precise circumstances under which they would become actual liabilitiesare frequently unclear.
The third and, perhaps, the most difficult phase in a debt sustainability evaluation is determining a debt sustainability threshold. In other cases, such limits have been imposed for specific groups of countries. Levels above 200 percent for the net present value of debt as a fraction of export revenues, for example, were experimentally associated with a much greater incidence of debt restructurings in severely indebted poor countries. For other non-industrial countries, there is some evidence that a debt-to-GDP ratio of 40% marks a tipping point where debt exposure risks begin to rise. This conclusion, on the other hand, reflects typical conditions in the countries investigated, such as a low amount of foreign assets. In general, when applying a debt threshold to particular countries, extreme caution is required. There is no single threshold that can consistently determine when a country’s debt becomes unsustainable, as country-specific factors and situations other than the debt ratio play a significant impact. For countries with quicker export growth, a larger share of exports in GDP, and a larger share of domestic-currency debt, higher debt ratios are less concerning.
Finally, judgments of sustainability are probabilistic: one can usually imagine certain world conditions in which a country’s debt is sustainable and others in which it is not. When determining whether a country’s debt exceeds prudent levels, there is always some element of judgment involved.
- Balance of payments and fiscal estimates for the medium terma cornerstone of the IMF’s work on member nations, notably as part of an IMF credit package;
- assessments of medium-term current account and real exchange rate sustainability, which affect public and external debt sustainability, particularly when debt is denominated in foreign currencies; and
- Financial sector stability evaluations are a more recent addition to the IMF’s toolkit; they help identify the financial system’s vulnerability to certain shocks, which could have significant repercussions for the government’s contingent liabilities.
The IMF recently created a standardized framework for analyzing debt sustainability based on these characteristics. The methodology focuses on the IMF’s basic medium-term predictions for a country’s economy and examines both fiscal and external debt sustainability. The methodology includes a standard set of sensitivity tests that generate debt dynamics under different assumptions about important variables, in addition to the baseline forecasts for public and foreign debt (including economic growth, interest rates, and the exchange rate). These alternate assumptions are based on each country’s own history, as evidenced by historical averages and volatility of the relevant variables.
The new approach could be useful in three scenarios. The methodology might assist identify vulnerabilitiesthat is, how the country might eventually stray into “insolvency territory”for countries with somewhat high indebtedness but no impending catastrophe. The methodology can be used to analyze the plausibility of the debt-stabilizing dynamics outlined in the program forecasts for countries on the verge of or in the midst of a crisis, enduring acute stress characterized by excessive borrowing costs or a lack of market access. Finally, after a default, the framework can be used to investigate debt dynamics in the aftermath of a possible restructure.
Would the new approach have helped in revealing weaknesses in Turkey in 1999, for example? Yes, it is correct. Even while the estimates did not appear overly optimistic in comparison to previous experience, the framework would have raised concerns about Turkey’s external debt situation in the case of unfavorable shocks.
IMF analysts did sensitivity tests of Turkey’s external vulnerability as it would have been seen at the time of the 1999 IMF arrangement approval to see if the framework would have been effective. The foreign debt ratio was expected to rise by 10% of GNP under the IMF-backed program, while much of this was expected to be offset by an increase in central bank reserves, so net external debt was expected to remain stable (in fact, to decline by about 2 percent of GNP between 1998 and 2001). The debt-to-GNP ratio, on the other hand, increased by about 30%. How did the employees of the International Monetary Fund miss the mark by such a big margin? The biggest source of inaccuracy was the trade imbalance, which was almost 6% of GNP more than expected in 1999-2000. This was due in part to the sharp spike in oil prices, but it was also due to a miscalculation of the imports’ reaction to increasing income. In addition, Turkey’s abrupt withdrawal from the currency rate peg in early 2001 significantly increased debt levels.
What would the framework’s predictions have been? Using five-year averages for the key parameters, it would have predicted a net debt rise of 6% of GNP, rather than the program’s projected fall of 2% of GNP. More importantly, the sensitivity tests would have revealed the projection’s vulnerabilities. In particular, the outcome of a 7% increase in the debt ratio between 1998 and 2000 (prior to the devaluation) was within the two-standard deviation shocks to either the interest rate, real GDP growth rate, or the noninterest current account deficit (this range captures most of the risks to the scenario). Furthermore, the two devaluation scenariosthe two-standard deviation shock to the US dollar deflator growth rate or the normal 30 percent devaluation shockwould have resulted in a net debt ratio increase greater than the 30 percent reported between end-1998 and end-2001.
The framework’s use is still new, but it will be gradually expanded to a wide variety of nations, both for surveillance and to inform IMF financial support choices, with appropriate revisions based on first experience. Although the goal is to bring more consistency and discipline to sustainability assessments, the framework is not meant to be used in a completely mechanical and rigorous manner: depending on nation circumstances, there may be solid reasons to deviate from it to some level. Simultaneously, the core idea of conducting baseline sustainability evaluations and calibrated sensitivity tests should hold true across countries. Finally, additional factors such as the debt structure (in terms of maturity composition, whether it is contracted on fixed or floating rates, whether it is indexed, and by whom it is held) as well as various other vulnerability indicators must be considered when interpreting the results generated by the framework. Market data, such as interest rate and spread expectations reflected in the position and shape of yield curves, access to new borrowing, and whether there have been any disruptions or difficulties in issuing long-term debt, can help put the findings into context.
This article is based on the IMF’s Policy Development and Review Department’s document “Assessing Sustainability,” which was published on May 28, 2002.
Emerging Financial Markets, David O. Beim and Charles W. Calomiris, 2001 (Boston: McGraw-Hill).
“Crises and Liquidity: Evidence and Interpretation,” IMF Working Paper 01/2, Enrica Detragiache and Antonio Spilimbergo, 2001. (Washington).
“Currency Crashes in Emerging Markets: An Empirical Treatment,” Journal of International Economics, Vol. 41 (November), pp. 351-66. Jeffrey Frankel and Andrew Rose, “Currency Crashes in Emerging Markets: An Empirical Treatment,” Journal of International Economics, Vol. 41 (November), pp. 351-66.
Assessing Financial Vulnerability: An Early Warning System for Emerging Markets, Morris Goldstein, Graciela Kaminsky, and Carmen Reinhart, 2000. (Washington: Institute for International Economics).
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Is there a country without debt?
Is the national debt important? Is this a sign of financial security? Not all of the time.
According to the IMF database, there is only one “debt-free” country. The relatively low national debt of many countries could be owing to a failure to present true data to the IMF.
Another situation in which a low national debt is a poor omen is when a country’s economy is so weak that no one wants to lend to them.
The ten least indebted countries in the world in 2020, according to IMF data:
How much debt is the world in 2021?
In the second quarter, debt as a percentage of GDP declined to roughly 353 percent, down from a peak of 362 percent in the first three months of this year.
According to the IIF, 51 of the 61 nations it studied had their debt-to-GDP ratios fall, owing to a significant recovery in economic activity.
However, it cautioned that the recovery has not been robust enough in many cases to bring debt ratios down below pre-pandemic levels.
Only five nations, according to the IIF, have overall debt-to-GDP ratios that are lower than pre-pandemic levels: Mexico, Argentina, Denmark, Ireland, and Lebanon.
China’s debt levels have risen faster than those of other countries, while emerging-market debt excluding China hit a new high of $36 trillion in the second quarter, primarily to increased government borrowing.
After a minor reduction in the first quarter, debt in developed economies, particularly the eurozone, climbed again in the second quarter, according to the IIF.
Although household debt climbed at a record rate, debt creation in the United States was the slowest since the start of the crisis, at roughly $490 billion.
In the first half of this year, global household debt increased by $1.5 trillion to $55 trillion. In the first half of the year, roughly a third of the nations studied by the IIF experienced an increase in household debt, according to the IIF.
“In practically every major country in the globe, rising housing prices have accompanied increased household debt,” said Tiftik of the IIF.
According to the IIF, total sustainable debt issuance has topped $800 billion this year, with global issuance expected to reach $1.2 trillion in 2021.
