Will Rising Federal Debt Slow Economic Growth?

In other words, one argument holds that a high and rising burden of debt crimps economic growth due to the "crowding-out" effect (that is, servicing the debt crowds out more productive spending and/or investments). A competing argument is that economic growth generally has been slowing over the past several decades—driven by demographics, globalization/competition, technology/innovation, and low inflation—which has led to increased government spending to try to boost growth, thereby increasing the deficit and, in turn, debt levels. The chart below represents the broadest measure of government debt, including federal government debt, state and local debt, and government-sponsored enterprise (GSE) debt (e.g., Fannie Mae and Freddie Mac). Courtesy of the strength of the economic rebound coming out of the lockdown phase of the pandemic—at the federal, state and local levels—government debt as a percentage of gross domestic product (GDP) has moved lower, which is good news (at least in relative terms).

Another way is for the government to reduce spending and/or increase taxes. Thanks to the removal of much of the pandemic-related direct fiscal stimulus, and the beneficial impact on tax receipts courtesy of the strong economic recovery coming out of the lockdowns, both are working in favor of bringing down the rate of debt growth. Finally, the government can also try to boost growth and inflation, such that the denominator (GDP) is growing faster than the numerator (debt). That was exactly what happened in the late 1940s, just after WWII. Today, however, inflation is growing much faster than the economy, as well as faster than wage and income growth.

What we do know now is that as the debt ratio was soaring, each additional dollar of debt lead to significantly less than a dollar's worth of economic growth. This is referred to as the "credit multiplier" or "money multiplier." More debt is unlikely to generate greater economic growth, other than perhaps for a short span of time. As noted earlier, the weight of debt also represents a weight on economic growth. For all the cheering of the June 2009 to February 2020 expansion being the longest on record, it was also the weakest on record, as shown below.