US Debt Sustainability Under Low Interest Rates and After the COVID-19 Shock

US federal debt held by the public rose from 35 percent of GDP in 2007 to 72 percent in 2015, reflecting the Great Recession as well as rising health and social spending, and then to 79 percent in 2019 following the 2017 tax cuts. In 2020-21 federal assistance to address the COVID-19 shock will reach over 25 percent of 2021 GDP. The prolonged trend of declining real interest rates since the early 1980s has reduced the real economic burden associated with a given debt to GDP ratio. In part because of new attention to interest rate versus growth rate dynamics, economic thinking has correspondingly shifted toward less concern about debt levels. Nonetheless, Congressional Budget Office projections adjusted for the $1.9 trillion American Rescue Plan indicate that the interest burden will rise from the recent 1½ percent of GDP to 2.3 percent by 2030 and 8.4 percent by 2050, as the debt ratio rises to 114 percent of GDP and 203 percent respectively. Feedback from the rising debt ratio boosts the real interest rate in the CBO’s model to about 1 percent by 2030 and 2½ percent by 2050. This study first estimates the ex-post realized real interest rate on federal debt over the past six decades. For projecting the debt burden, it suggests a prudential benchmark at the 33rd percentile in the past distribution, a real rate of 1 percent on the 10-year treasury note. Simulations of the CBO-based projections using this rate, which is higher in the 2020s but lower thereafter, find an interest burden of 4.7 percent of GDP by 2050, far above the average of 1.9 percent over the past six decades. At a real rate of 1 percent, classic Maastricht fiscal targets would shift to about 130 percent of GDP for the debt ceiling and 4 percent for the deficit. However, even these more lenient targets would not be met unless primary deficits are cut to about 1 to 2 percent of GDP, well below their current path rising from about 3 percent of GDP to 4.5 percent by the 2040s as social security and especially health outlays escalate. The broad finding of this study is that the US debt burden is on a long-term path to unprecedented heights even when measured by interest payments, despite the low interest rates of recent years. This diagnosis remains valid for an alternative metric of real debt service to real GDP. Curbing primary deficits will be necessary to moderate this precarious path.