Tuesday, August 02, 2011

Our Tiny Little Debt Problem

One of the oddities about the recent debt debate is the failure to recognize how small our problem is in one critical sense. While our deficits and government debts are high in absolute terms and high in relation to GDP, because interest rates are low, our debt service costs are actually quite low as well.

Going back 20 years to 1991, net interest as a percentage of federal government outlays has fluctuated between 5.0% (the low-point in 2010) and 15.4% (1996). This year, the estimated net interest expense is 6.5% of outlays, near the low end of the spectrum. As a percentage of GDP, the government’s interest expense is less at 1.6%, about as low as it has been since the 1960s. These figures, however, are expected to rise, partly due to an assumption that interest rates will rise and partly due to the rising debt level. Countries with real debt problems like Greece or Italy are required to pay interest rates that are many times the rate on U.S. treasury bonds.

But even after the projected increases, our federal debt service will remain low by historical norms. So there may be no real crisis and no reason to expect that the ratings agencies have any legitimate reason to downgrade U.S. bonds (except perhaps the government’s apparent inability to increase revenues above their historically low levels).