Why Yellen isn’t losing sleep over the US borrowing that worries most Americans

(Bloomberg) — Whether they support the debt limit or not, most Americans are alarmed by the level of US government borrowing. Treasury Secretary Janet Yellen is not one of them.

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Debt outstanding held by the public was $23.9 trillion at the end of 2022. That’s 97% of gross domestic product, using the most popular measure among economists — about triple that. what it was 20 years ago, and should continue to climb. He is a figure at the heart of the fight against the debt ceiling which is moving towards a resolution.

“We have the highest debt we’ve ever had before,” House Speaker Kevin McCarthy – who brokered a deal with the Biden administration to cut spending – said on May 24 and must push it through. Congress this week to avoid a default. don’t think that’s right. Many others, including Federal Reserve Chairman Jerome Powell, have warned that the trajectory of US debt is “unsustainable”.

Don’t count Yellen among the alarmists, though. This is partly because it uses a different debt criterion.

The former Fed chairman, considered by many to be the nation’s most experienced economic policymaker, shows little concern when pondering government spending. “It’s not something to feel like we’re in a dire situation,” she told Bloomberg News in a May 13 interview.


One of the reasons she is optimistic is that Yellen is among a number of prominent economists to adopt an alternative method for measuring national debt sustainability. Instead of viewing the outstanding stack of bonds as part of the output of the economy, it prefers the ratio of interest payments – especially, after adjusting for inflation – to GDP.

In other words, take the amount of money the government spends on interest payments in a given year, divide by the size of the economy, and then subtract inflation. The lower the result, the better.

With all the caveats that public finances and household budgets are fundamentally different things, the logic is similar to assessing the affordability of a mortgage. What matters most isn’t necessarily the amount borrowed, but how much a homeowner has to pay each month or year relative to their income over the same period.

McCarthy prefers the analogy of a credit card. He likened the Democrats to a family that “charged, and year after year they kept raising the limit, until they owed more money on the credit card than they earned. in a whole year”.

Using Yellen’s preferred measure, the rising public debt burden has not imposed many interest burdens, at least so far.

The government’s interest bill has fallen over the past few decades in proportion to the economy, thanks to lower borrowing costs over the period. Net interest as a percentage of GDP, unadjusted for inflation, has averaged around 1.5%, although it spiked to 1.9% in 2022 after the pandemic borrowing spike.

Factor in inflation and the interest-to-GDP ratio has often been negative, even before the burst of post-Covid price hikes. Looking ahead, the White House Office of Management and Budget expects the Yellen measure to rise above zero in 2024 as inflation ebbs and then peaks at 1.1% in 2032-33. It’s a level that the Treasury Secretary says is “quite reasonable”.

“Bloated Away”

Jason Furman, a Harvard University professor and former economic adviser to President Barack Obama, agrees. In a 2020 article, he and former Treasury Secretary Lawrence Summers argued that policymakers should aim to prevent real net interest from rising above 2% of GDP.

Yellen’s preferred measure is the right one to use, Furman says, because it’s important to consider the opposing effects that interest charges and inflation have on debt burdens.

When rates and prices both go up, Furman says that “in a sense, next year’s debt is even bigger than this year’s debt, because it goes up with interest. But in another sense, next year’s debt is smaller, because part of it is inflated, so you don’t need to repay as much.

Still, Furman admits that the 2% threshold he and Summers arrived at for real net interest to GDP is “arbitrary.” It’s based on looking at experience in other countries, historical experience in the United States, our instincts, et cetera. I’m not sure that’s fair.

His co-author Summers, who is a paid Bloomberg Television contributor, warned earlier this year that a rising debt burden could end up pushing up interest rates, adding pressure on the budget deficit. and could turn into a “vicious circle”.

‘Risk management’

More than a precise level, it is the trajectory of the debt that can prove to be critical. A big threat to those watching the Yellen measure is a scenario in which interest rates remain high even after inflation falls. This would see debt service costs adding to the burden without being offset by rising prices, as is currently the case.

This, Yellen acknowledged, would pose considerable problems. But she doesn’t expect that to happen because she’s in the camp of economists who anticipate a return to the regime of low inflation and low rates that has dominated the past two decades once the pandemic price spike is over. controlled by the Fed.

Wendy Edelberg, former chief economist at the Congressional Budget Office, says better budgeting will be needed in the long run because “you can’t ask the federal government to take actions over time that perpetually reduce the amount of savings into the economy and perpetually crowds out ever more private investment.

In the meantime, she advocates keeping tabs on a range of debt metrics to determine where danger may be lurking. “Part of it is just risk management,” she says.

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