One of the more amusing exercises on the economic calendar is the International Monetary Fund’s annual review of the United States. Yet while everyone knows that the U.S. government pays absolutely no heed to what the IMF has to say about its affairs, the Fund’s most recent Article IV review of the U.S. economy is striking for one unexpected finding. Readers will be startled to learn that, in the IMF’s estimation, U.S. government debt is on a sustainable path.
This conclusion reflects consensus assumptions about the evolution of inflation, GDP growth, interest rates, and budget deficits. It is of course hazardous to attempt to forecast these variables for a period of 10 years, much less for 30 years, the horizon over which the U.S. Congressional Budget Office undertakes an analogous exercise. The assumptions adopted by the two institutions differ in their particulars, the CBO being slightly more optimistic about America’s growth prospects, for example. But while both institutions foresee debt rising over the next ten years, neither sees it spiraling out of control.
To understand why, it is important to begin from the appropriate starting point. This is not total federal government debt, but rather debt in the hands of the public. A non-negligible share of total U.S. federal debt is held by the government itself, notably in the Social Security Trust Fund. The Treasury’s interest payments on this portion represent interest income for the Trust Fund. On this share of its debt, the government is simply making interest payments to itself.
Debt in the hands of the public is currently 100% of GDP—an elevated level by advanced-economy standards, but by no means catastrophic. CBO sees this rising, assuming no changes in prevailing law, to 116% of GDP in 2034, 139% in 2044, and 166% in 2054.
These levels look alarming. But Japan has shown that an advanced economy that borrows in its own currency can manage debts of this magnitude. Factors limiting the risk of a debt crisis, as the IMF notes, include the depth of U.S. financial markets, the breadth of the investor pool, the dollar’s role in the international system, the Federal Reserve’s ability to backstop the Treasury bond market, and the strength of American institutions.
What then could go wrong? Well, U.S. institutions could turn out not to be so strong. Donald Trump has a personal history of defaulting on his debts. As William Silber has observed, Trump in a second presidential term could instruct his Treasury secretary to suspend payments on the debt, and neither Congress nor the courts might be willing to do anything about it. The gambit would be appealing to Trump insofar as a third of U.S. government debt is held by foreigners.
The damage to the dollar’s safe-asset status would be severe, even if Congress, the courts, or a subsequent president reversed Trump’s suspension of debt payments. Investors in U.S. Treasuries would demand a hefty risk premium, potentially causing the government’s interest payments to explode.
Even absent this dire scenario, meeting additional interest obligations as the debt ratio rises could require the federal government to cut discretionary spending, with negative implications for economic growth. The subsidies offered by the CHIPS and Science Act are designed to stimulate growth by encouraging investment in high-tech capacity and knowhow. Similarly, the Inflation Reduction Act’s tax credit for investment in clean energy is intended to avert disruptive climate events that could impede economic growth rate and depress the level of GDP.
Higher spending on interest payments will mean either more debt, testing sustainability, or less investment in these other priorities, jeopardizing growth. The CBO expects discretionary spending by the federal government as a share of GDP to fall by about a fifth from current levels by 2034—without, however, inferring from this contraction much adverse impact on the overall rate of economic growth.
But if the cuts fall on public investment in semiconductors, quantum computing, clean energy, and education, as seems likely, then the negative growth effects could be substantial. And sharply slower growth would throw debt sustainability into doubt.
The IMF offers a lengthy menu of possible measures for closing the budget deficit and stabilizing the debt. Revealingly, most of the options with quantitative oomph operate on the revenue side of the budget, reflecting the reality that tax revenues as a share of GDP are low by advanced economy standards. These include eliminating tax deductions for state and local taxes, mortgage interest, sale of one’s principal residence, and employer-based health care, and raising corporate tax rates and adding a value-added tax and/or a carbon tax.
In your dreams, it is tempting to say. Still, the IMF, unlike the rest of us, is entitled to dream.
Barry Eichengreen, professor of economics and political science at the University of California, Berkeley, is a former senior policy advisor at the International Monetary Fund. He is the author of many books, including In Defense of Public Debt (Oxford University Press, 2021).