A member of Putnam's Fixed Income team since 2007, Onsel Gulbiten analyzes macroeconomic issues, including inflation, interest rates, and policy developments.
As inflation sticks around, it is important to think about how it is related to high government debt.
- Debt has risen ever since the global financial crisis (GFC) in 2008, with increases from the tax cuts in 2017–2018 and the massive Covid response of 2020–2021.
- The Federal Reserve's efforts against inflation so far have not caused rising unemployment or financial instability.
- As tightening continues, central banks might face a trade-off between inflation and a debt crisis.
The U.S. debt problem
The public debt-to-GDP ratio was around 60% before the 2008 GFC and the related recession. This deep downturn that unavoidably increased debt was later followed by procyclical fiscal policies during an expansion. Then, Covid arrived. A large fiscal stimulus was followed once again by expansionary policies when the economy was already recovering with vigor. As a result, the U.S. debt is today about 120% of GDP, and this does not include future Social Security and Medicare obligations of the U.S. government.
When debt surged after the GFC, quiet financial repression took place — governments and central banks suppressed interest rates and helped reduce the debt stock. The private sector deleveraged, and the Fed implemented QE, keeping the real rate on U.S. Treasuries paid to finance the deficit below the real growth rate. This helped slow the rise of the government debt-to-GDP ratio, although it did not reverse the direction. Inflation and growth remained low, and the fiscal policymakers did not see any urgency to actively reduce debt. Thanks to the private sector deleveraging, inflation remained low.