The Cost of Debt Crises

Highlights

• In 2027, U.S. debt will reach the highest level ever recorded in U.S. history as a share of the economy. 
• Under current projections, U.S. debt will continue to accumulate to over 122 percent of GDP by 2034, even under benign assumptions
• Recent research published by the National Bureau of Economic Research surveyed 212 debt crises and found that defaulting nations suffered long-term diminution in standards of living, with associated deterioration in social and health outcomes. 

In June, the Congressional Budget Office (CBO) released its periodic update on the nation’s fiscal and economic outlook. Congress’ chief budget watchers provide a series of budgetary superlatives that underscore just how stark the nation’s budget challenges are:

• “In CBO’s projections, total deficits equal or exceed 5.5 percent of GDP in every year from 2024 to 2034. Since at least 1930, deficits have not remained that large for more than five years in a row. Over the past 50 years, the total annual deficit has averaged 3.7 percent of GDP.

• Since 1940 (the first year for which OMB reports such data), net outlays for interest have never exceeded 3.2 percent of GDP. In CBO’s baseline, such outlays exceed that percentage in every year from 2025 to 2034.

• Over the 10-year projection period, primary deficits in CBO’s baseline average 2.5 percent of GDP. In the 62 years from 1947 to 2008, primary deficits exceeded 2.5 percent of GDP only twice. In the past 15 years, though, they have exceeded that percentage 10 times—in part because of legislation enacted in response to the 2007–2009 financial crisis and in the wake of the coronavirus pandemic that began in early 2020.”

The net effect of these mounting deficits is a projected level of debt higher than any period in U.S. history, including World War II. Specifically, U.S. debt previously peaked at 106.1 percent of GDP in 1946, just after the end of perhaps the most disruptive period in modern history. Under current projections, the U.S. will surpass that record in 2027.

Notably, this projection relies on several benign assumptions: no major U.S. conflicts, no recessions, and the scheduled expirations of numerous fiscal policies that will likely be extended, such as the Tax Cuts and Jobs Act. The U.S. is on the road to fiscal ruin and there appears little appetite among policymakers to find an offramp. 

While it is unlikely that a national consensus on fiscal consolidation will be inspired by a National Bureau of Economic Research (NBER) working paper, policymakers should take note of recent research on the social costs of debt crises published this month.

In The Social Costs of Sovereign Default , authors Juan P. Farah-Yacoub, Clemens M. Graf von Luckner, and Carmen M. Reinhart examine 221 debt defaults and detail the legacy of those debt crises. Covering defaults over the period 1815 to 2020, the authors find materially deteriorated economic outcomes for the affected nations’ citizenry. Specifically, they found that within three years of default, standards of living (real GDP per capita) lagged that of nondefaulting countries by 8.5 percent. After a decade, the gap widened to 20 percent. 

These economic deteriorations push more households into poverty with associated diminished social outcomes. The authors found that 10 years after a default, 10 percent more households in the defaulting nation are living in poverty compared to nondefaulting nations. Similarly, health outcomes suffer as evidenced by higher infant mortality and shorter life expectancies.

While the U.S. is not presently at risk of immediate default, lawmakers. must nevertheless confront the reality that what cannot continue indefinitely must eventually stop. The nation’s debt growth is unsustainable – how it comes to a stop is not merely an accounting abstraction, but has very real implications for Americans.