The National Debt Can Crowd Out Investments in the Economy — Here’s How
The federal government is slated to borrow about $1.9 trillion in 2026, and that annual shortfall is projected to grow to $3.1 trillion by 2036. One consequence of issuing such large amounts of federal debt is that it could “crowd out” investments by the private sector, making the economy less productive and stunting wage growth.
How Does Federal Borrowing Affect Private Investment in the Economy?
To cover its budgetary shortfalls, the federal government raises money by issuing debt in the form of Treasury securities. That debt is purchased by investors such as banks, investment funds, businesses, foreign governments, and individuals because it is generally considered a safe investment. However, the cash used to purchase such debt could alternatively be used for investment in private entities. Therefore, as government borrowing increases, fewer resources are available for other investments, which can hamper economic activity.
Furthermore, increased federal borrowing puts upward pressure on interest rates. A Congressional Budget Office (CBO) study found that each percentage point increase in the debt-to-GDP ratio boosts inflation-adjusted 10-year interest rates by two basis points (.02 percentage points). The debt-to-GDP ratio is approximately at 100 percent, and CBO projects that it will climb to 120 percent in the next decade, so by CBO’s measure, interest rates would be approximately 0.6 percentage points higher than they otherwise would be due to the country’s rising debt.
Higher interest rates raise the price of borrowing, thereby deterring private investment. According to CBO’s estimation, the net result of this trade-off is that for every dollar the federal deficit increases, private investment would fall by 33 cents.
The reduction in private investment due to rising interest rates and fewer available resources can slow economic growth over time. Reduced investment in capital and workers would cause firms to be less productive and lead to lower compensation.
As the Brookings Institution notes, “Deficits are costly to future generations to the extent they reduce national saving. A reduction in saving can reduce private investment, leaving a smaller capital stock (known as ‘crowd out’), higher interest rates, and lower GDP in the future. A reduction in national saving can also induce an influx of foreign capital; these foreign flows offset the impact of deficits on the domestic capital stock, GDP, and interest rates but increase the foreign ownership of U.S. assets. In either case, deficits mean that national wealth (and the net present value of future national income) is lower than it otherwise would be.”
Conclusion
There is a direct and critically important linkage between the country’s fiscal condition and its economic outlook through the effect on private investment and interest rates. The federal government can tax and spend equitably, promoting economic growth and investing in national priorities. But it also must take care to do it effectively and responsibly, making sure not to restrain investment, which would hinder opportunity and prosperity for future generations.
Further Reading
Quarterly Treasury Refunding Statement: Higher Borrowing Compared to Last Year
The United States is expected to borrow less over the next six months than it did over the same period last year — but there are signals that borrowing may increase in the months ahead.
The Rising National Debt Means Fewer Jobs, Lower Wages for Young People
The national debt is growing faster than ever, and the consequences for the job market are serious.
How Does the National Debt Affect Inflation, Housing Costs, and the Job Market for Young People?
The unsustainable national debt poses a risk to our economic future, and young Americans may have the most to lose.