There is always a lot of controversy around the implications of high and rising government debt. Over the past 70 years, rising government debt has generally been accompanied by weaker economic activity. The cause and effect can be debated, and there is also a bit of a chicken-and-egg, or “circular” argument: High and rising debt is a burden on growth, but low levels of growth also trigger an increase in government spending, higher budget deficits and higher debt.
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).
Federal debt began to exceed gross domestic product around 2001
Is rising debt inflationary?
Although it’s not supported by any historical data, there is a persistent concern expressed about high debt and whether it will lead to serious and persistent inflation. The visual below looks at every decade since the 1970s—each color-coded. It shows the relationship between debt as a percentage of gross domestic product (GDP) and the inflation rate, as measured by the core personal consumption expenditures (PCE) measure (which is the Federal Reserve’s preferred metric). As shown, as debt growth has expanded as a share of GDP, inflation has been moving lower, not higher—notwithstanding the recent spike in inflation due largely to COVID-19-specific supply/demand dislocations.
While debt growth has expanded as a share of GDP, inflation has moved lower