A heated debate has flared up in Germany about the usefulness of the debt brake. The current regulation actually offers the government enough flexibility, but they don’t want to take advantage of it. In the USA, on the other hand, the path is completely different, which has led to a significant increase in the deficit in the state budget. In particular, tax cuts and rising social costs have significantly widened the gap in the US federal budget.
Above all, the financial relief for companies and private households has provided positive economic impulses. According to estimates, the tax cuts by the Trump government have relieved companies by around USD 80 billion and private households by around USD 120 billion. This alone should have contributed to growth of around 0.7 percentage points. With expected GDP growth of 2.3% yoy in 2019, this is a not inconsiderable contribution. Whether planned or not, with these measures the US government has built up the economy vigorously before the trade sanctions with China were broken. This was an advantage that became increasingly noticeable in the course of 2019.
The whole thing, of course, has a price in the form of a constantly growing deficit. For example, the gap in the federal budget in the fiscal year 2018/2019 grew to around USD 1 trillion or almost 6% of GDP. From an EMU perspective, this is an incredibly high deficit. In recent years, solid economic growth has actually been recorded, underscoring once again the high dynamics of debt. Nevertheless, the gap in the budget has almost reached the same magnitude as after the last major financial and economic crisis.
The growing national debt naturally raises the question of the long-term sustainability of the debt burden. What would be to be expected, for example, if the interest rate for new debt were to rise visibly? This could be the case if significantly higher inflationary pressure forces the central bank to take countermeasures and, at the same time, foreign demand for US government bonds declines significantly.
In absolute terms, although interest payments have risen visibly in recent years, their share of GDP was only 1.8 percent in 2019. Nevertheless, an abrupt rise in interest rates would place an additional burden on the treasury. In the extreme case of an abrupt rise of one percentage point, the Ministry of Finance would have to finance additional debt of around USD 10 billion in the current fiscal year. In relation to GDP, however, the budget deficit would change only in the second decimal place, the increase would be around 0.05 percentage points. Thus, interest payments do not limit debt sustainability.
This also applies to the demand for US government bonds. In the past, the financial markets have hardly responded to the higher budget deficits and the associated higher issue volume of US government bonds. In the medium term, yields could rise with a persistently high issue volume of US government bonds. Overall, however, the correlation between rising yields and rising debt is likely to remain relatively small for the foreseeable future.
In the end, one can ask oneself whether US fiscal policy is not the right way to go, at least for the US. Rising debt has positive effects on growth and labour markets, while corporate profits and household incomes are rising. The negative effects of rising debt, on the other hand, appear to be relatively small. The latter probably applies only up to a certain level of debt, but this does not seem to have reached the US by a long shot. In addition, the global interest rate trend is pointing downwards, which will further increase debt sustainability.
Only when the capital market returns to „normal“ interest rates will it become apparent that an ever-growing debt pyramid is not a sustainable economic policy.