Federal government debt has nearly doubled since President Barack Obama took office and is projected to increase 50 percent over the next decade—and then rise rapidly thereafter—under existing policies.[1] As federal debt has soared, so have concerns about America’s future.

Used properly, debt can safely finance private and government investment in productive capital to support economic growth. But too much debt can ruin a family, a business, or a nation.[2]

Fiscal Outlook Bleak

Some in Congress and the media argue that the recent improvement in the deficit means no more need be done this year to rein in spending. While deficits have improved somewhat due to the fiscal cliff tax increases and discretionary spending cuts from the Budget Control Act, this improvement is transient. By the end of the decade, the deficit will again approach $1 trillion as entitlement spending takes off.

Recent progress on the deficit is also woefully inadequate. Debt will continue to soar over the next decade: Debt held by the public will increase from $11 trillion in 2012 to $19 trillion in 2023. Debt subject to the legal debt limit—which includes debt owed to federal trust funds such as Social Security’s—will swell by $9 trillion, reaching $25 trillion after a decade. The result is highly likely to eventually spur exceptionally high interest rates and a slower economy.

U.S. Debt Levels Dangerous and Becoming More So

Recent and projected growth in U.S. government debt poses a serious hazard to the nation. Clearly, high levels of government debt mean that substantial government resources must go toward paying interest on that debt, often called servicing the debt. And a growing body of research supports the economic theory that high levels of debt relative to the size of the economy, sometimes called the debt ratio, eventually lead to unusually high interest rates and slower growth.

One traditional explanation relating government debt ratio and interest rates, referred to as "crowding out,” observes that government borrowing subtracts from domestic saving available to private borrowers, who then bid up the price of their borrowing, which, of course, is the interest rate they pay. That works in a closed economic system, but that is not the way the world works today.

Rather, the ability to tap into foreign savings by borrowing from abroad, as the U.S. is doing, appears largely to defuse this simple crowding-out effect at moderate debt ratio levels. This may explain in part the U.S.’s currently low interest rates. However, the foreign appetite for any nation’s debt is not unlimited. At some point, U.S. debt issuance would become so great relative to foreign demand that market resistance would drive up U.S. interest rates just as though the conventional crowding-out effect were in full force.

Rising Debt, Rising Interest Rates: The Developing Consensus

The relationship between interest rates and government debt issuance depends on many factors, yet one abiding conclusion stands out: When debt gets high enough or rises fast enough, markets notice and interest rates rise.

A team of prominent economists recently delved[3] more deeply into the influence borrowing abroad has on the interest rate effects of government borrowing by including in the analysis a nation’s current account deficit—essentially the net value between the value of what a nation exports and the value of what it imports.[4] Their results strongly suggest that the ability to borrow from abroad at moderate levels of debt likely reduces borrowing costs as expected, but the advantages of being able to borrow abroad rapidly dissipate as foreign bond buyers respond more quickly by demanding higher interest rates as either the debt share or the current account deficit increases.

The authors further observed that interest rate problems "can arrive quickly and dramatically once the debt loads and current-account deficits get sufficiently high.”

-Alison Acosta Fraser and J.D. Foster, Ph.D. - Heritage.org