What is the significance of national debt

The largest deficit thus far goes to President Barack Obama. He also cut taxes and increased military spending. Although the national debt under Obama grew the most dollar-wise, it wasn't the biggest percentage increase. That honor goes to President Franklin D. He did this to fight the Great Depression and prepare the U. President Donald Trump is the second-largest contributor to the debt dollar-wise. Trump's fiscal year budgets also added to the debt before the pandemic hit.

Every president borrows from the Social Security Trust Fund. Over the years, the Fund has taken in more revenue than it needed through payroll taxes leveraged on the baby boomer generation. Ideally, this money should have been invested to be available when members of that generation retire. Instead, the Fund was "loaned" to the government to finance increased spending.

This interest-free loan helps keep Treasury bond interest rates low, allowing more debt financing. But, it must be repaid by increased taxes as more individuals retire. Foreign countries like China and Japan buy Treasurys to invest their export proceeds that are denominated in U. They are happy to lend to America—their largest customer—so that it will keep buying their exports. It couldn't keep running budget deficits if interest rates skyrocketed.

Why have interest rates remained low? Purchasers of Treasury bills are confident that the U. During recessions, foreign countries increase their holdings of Treasury bonds as a safe-haven investment. Congress sets a ceiling on the debt but raises it frequently. Since , Congress has modified the U. President Trump signed the Bipartisan Budget Act of that suspended the public debt limit through July 31, On Aug. Congress will need to decide what to do once again—raise the debt ceiling, suspend it, or require the government to make changes in order to reduce the debt.

In the short run, the economy and voters benefit from deficit spending because it drives economic growth and stability. The federal government pays for defense equipment, health care, building construction, and contracts with private businesses. New employees are then hired and they spend their salaries on necessities and wants, like gas, groceries, new clothes, and more.

This consumer spending boosts the economy. Over the long term, debt holders could demand larger interest payments. This is because the debt-to-GDP ratio increases and this high ratio of debt to gross domestic product GDP tells investors that the country might have problems repaying them.

That's a newer—and worrying—occurrence for the U. Back in , the national debt was only half of what the U. Weakened demand for U.

Treasurys could increase interest rates and that would slow the economy. Lower demand for Treasurys also puts downward pressure on the dollar because its value is tied to the value of Treasury securities. As the dollar value declines , foreign holders get paid back in a currency that is worth less than when they invested.

However, there is a limit to how much debt can be monetized before a country starts suffering from inflation , or even hyperinflation. Efforts to monetize debt have often pushed countries well past that point. Monetizing debt can also make creditors less likely to lend to a country if inflation significantly lowers the value of what creditors are repaid.

Maintaining low interest rates is one method that governments use to stimulate the economy, generate tax revenue, and, ultimately, reduce the national debt. Low interest rates make it easy for individuals and businesses to borrow money. In turn, the borrowers spend that money on goods and services, which creates jobs and tax revenues. Low interest rates have been employed by the United States, the European Union, the United Kingdom, and other nations with some degree of success.

That noted, interest rates kept at or near zero for extended periods of time have not proved to be a panacea for debt-ridden governments. One way to cut debt is to cut spending. This can be difficult in two ways. First, each government expenditure has its own constituency that will fight efforts to cut that expenditure, making spending cuts politically difficult. Secondly, if done during a severe economic downturn, spending cuts can damage the economy through a negative multiplier effect. This can cut revenue enough that it can actually impair the ability to repay debts, so spending cuts must be done carefully.

On the other side of the ledger are tax increases. In the United States, federal government revenues have been below their 50 year average of However, just like cutting spending, raising taxes can be politically difficult as various interest groups will defend their own tax exemptions.

Raising taxes can also have a negative multiplier effect, which can complicate efforts to reduce debt. A number of countries have been given debt bailouts, either by the International Monetary Fund IMF , in the case of many countries through the past several decades, or by the European Union EU , as was most prominently the case for Greece during the European debt crisis.

These bailouts often come with the requirement to impose harsh reforms on a country's economy, and there is substantial debate as to whether or not the structural adjustments the IMF or EU have imposed on bailed-out countries have had an overall positive or negative effect.

Defaulting on the debt, which can include going bankrupt and or restructuring payments to creditors, is a common and often successful strategy for debt reduction. Debt reduction and government policy are seriously polarizing political topics. Critics of every position take issues with nearly all budget and debt reduction claims, arguing about flawed data, improper methodologies, smoke-and-mirrors accounting, and countless other issues.

For example, while some authors claim that U. Similar conflicting arguments and data to support them can be found for nearly every aspect of any discussion of federal debt reduction. While there are a variety of methods countries have employed at various times and with various degrees of success, there is no magic formula that works equally well for every nation in every instance.

The national debt is the accumulation of the nation's annual budget deficits. A deficit occurs when the Federal government spends more than it takes in. To pay for the deficit, the government borrows money by selling the debt to investors. Supply and demand. In other words, the marketplace.

When the government accumulates debt it sells that debt to the highest bidders through an auction. Bidders offer to buy the debt for a specific rate, yield, or discount margin. The government chooses the best deal. As of Oct. Tax Policy Center. National Debt Clock. Debt Clock. Federal Reserve Bank of New York. Department of the Treasury. National Priorities Project.

International Monetary Fund. Accessed Oct. Office of the Historian. Debt and Foreign Loans, — Congressional Budget Office. The World Bank. Council on Foreign Relations. Debt Ceiling: Costs and Consequences. Center on Budget and Policy Priorities. Social Security Administration. Pew Research. Kaiser Family Foundation. Peter G. Institute for Research on Labor and Employment. The White House. Peterson Foundation. Watson Institute.

Defense Spending Compared to Other Countries. Brown University. Treasury Securities. Trading Economics. Treasury Direct. Tax Laws. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data. We and our partners process data to: Actively scan device characteristics for identification.

I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Part Of. Biden Policies. Biden's Team. Personal Finance Issues of Economic Issues of Table of Contents Expand. National Debt vs. The amount of the U.

In theory, GDP represents the total market value of all final goods and services produced in a country in a given year. Based on this definition, one has to calculate the total amount of spending that takes place in the economy to estimate the country's GDP. One approach is the use of the expenditure method , which defines GDP as the sum of all personal consumption of durable goods, nondurable goods and services; plus gross private investment, which includes fixed investments and inventories; plus government consumption and gross investment, which includes public-sector expenditures for services such as education and transportation, less transfer payments for services such as Social Security; plus net exports, which are simply the country's exports minus its imports.

Given this broad definition, one should realize the components that comprise GDP are hard to conceptualize in a manner that facilitates a meaningful evaluation of the appropriate national debt level. As a result, a debt-to-GDP ratio may not fully indicate the magnitude of national debt exposure.

Therefore, an approach that is easier to interpret is simply to compare the interest expense paid on the national debt outstanding to the expenditures made for specific governmental services such as education, defense, and transportation. When debt is compared in this manner, it becomes plausible for citizens to determine the relative extent of the burden placed by debt on the national budget. While the national debt can be precisely measured by the Treasury Department , economists have different views on how GDP should actually be measured.

The first issue with measuring GDP is it ignores household production for services such as house cleaning and food preparation. As a country develops and becomes more modern, people tend to outsource traditional household tasks to third parties. Given this change in lifestyle, comparing the GDP of a country today to its historical GDP is significantly flawed because the way people live today naturally increases GDP through the outsourcing of personal services.

Moreover, GDP is typically used as a metric by economists to compare national debt levels among countries. However, this process is also flawed because people in developed countries tend to outsource more of their domestic services than people in lesser-developed countries. As a result, any type of historical or cross-border comparison of debt in relation to GDP is completely misleading.

The second problem with GDP as a measurement tool is it ignores the negative side effects of various business externalities. For example, when companies pollute the environment, violate labor laws, or place employees in an unsafe working environment, nothing is subtracted from GDP to account for these activities.

However, the capital, labor, and legal work associated with fixing these types of problems are captured in the calculation of GDP. Technology not only increases GDP but also improves the quality of life for all people. Unfortunately, technological advances do not take place in a uniform manner each year.

As a result, technology may skew GDP upward during certain years, which in turn may make the relative national debt level look acceptable when it is not.

Most ratios must be compared based on their change through time, but GDP fluctuations result in errors of calculation. The national debt has to be paid back with tax revenue, not GDP, although there is a correlation between the two. Using an approach that focuses on the national debt on a per capita basis gives a much better sense of where the country's debt level stands. Comparing the national debt level to GDP is akin to a person comparing the amount of their personal debt to the value of the goods or services they produce for their employer in a given year.

Clearly, this is not the way one would establish their own personal budget , nor is it the way the federal government should evaluate its fiscal operations. Given that the national debt has recently grown faster than the size of the American population, it is fair to wonder how this growing debt affects average individuals. While it may not be obvious, national debt levels directly affect people in at least five ways.

First, as the national debt per capita increases, the likelihood of the government defaulting on its debt service obligation increases, and therefore the Treasury Department will have to raise the yield on newly issued treasury securities to attract new investors.

This reduces the amount of tax revenue available to spend on other governmental services because more tax revenue will have to be paid out as interest on the national debt. Over time, this shift in expenditures will cause people to experience a lower standard of living , as borrowing for economic enhancement projects becomes more difficult.

Second, as the rate offered on treasury securities increases, corporations operating in America will be viewed as riskier, necessitating an increase in the yield on newly issued bonds.

This, in turn, will require corporations to raise the price of their products and services to meet the increased cost of their debt service obligation. Over time, this will cause people to pay more for goods and services, resulting in inflation.

Third, as the yield offered on treasury securities increases, the cost of borrowing money to purchase a home will increase because the cost of money in the mortgage lending market is directly tied to the short-term interest rates set by the Federal Reserve and the yield offered on treasury securities.

Given this established interrelationship, an increase in interest rates will push home prices down, because prospective home buyers will no longer qualify for as large of a mortgage loan since they will have to pay more of their money to cover the interest expense on the loan they receive. The result will be more downward pressure on the value of homes, which in turn will reduce the net worth of all homeowners.

Fourth, since the yield on U. Treasury securities is currently considered a risk-free rate of return, and as the yield on these securities increases, risky investments such as corporate debt and equity investments will lose appeal. This phenomenon is a direct result of the fact it will be more difficult for corporations to generate enough pre-tax income to offer a high enough risk premium on their bonds and stock dividends to justify investing in their company.

This dilemma is known as the crowding out effect and tends to encourage the growth in the size of the government and the simultaneous reduction in the size of the private sector.