The National Debt

A Look at the Past and the Present. The Good and the Bad.
Macroeconomics E202- April 15, 2019

By: Lenore Wooten, Kylie Crawford, Roy Byrd © 2019

 The federal budget and debate national debt has been a hot button topic of debate

between politicians and economists alike for most of the 21st Century. It is an important topic and

one that most people are uncomfortable discussing. What is the national debt and how is the debt

created? Who measures and tracks the national debt? What, if any positive effects does the debt

have on the US Economy? Conversely, what, if any negative effects does the debt have on the

US Economy? If we quickly paid off the national debt in its entirety, how would that affect the

US Economy? Conversely, if we paid the debt off slowly, how would that decision affect the US

Economy? These are the questions that this paper will attempt to answer and explain.

Definitions:

- US National Debt (National Debt) - the amount of borrowed funds (debt) owed by the United

States Government.

- Federal Budget- the budget set forth by the United States government annually that provides a

detailed outline of all government spending for a specific fiscal year.

- National Deficit- represents an increase to the US national debt as the government spends

more than it makes in revenue in a year.

- National Surplus- represents a decrease to the US national debt as the government makes

more in revenue than it spends in a year.

- Intragovernmental Holdings- US debt held by other governmental agencies

- Public Debt (Debt Held by the Public) - US debt held outside of the government

- Debt Ceiling- a legislative limit set by Congress on the amount of debt the federal government

is allowed to hold.
History of the US National Debt

The United States has had debt since our nation’s birth. Treasury records show that by

1791, the US incurred $75.4 million dollars during the Revolutionary War. In the 45 years that

followed, US debt continued to grow. The debt was notably zero in 1835 under President

Andrew Jackson, but of course quickly grew again and reached $1 billion by 1863. It grew to

$2.7 billion following the Civil War. The US debt would continue to grow, reaching $22 billion

by WWI and $260 billion following WWII. For nearly 40 years following WWII, the growth of

the national debt was closely tied to the inflation rate. That is due to the fact that generally,

inflation rates lead to higher tax revenues for the government. The national debt tripled between

1980 and 1990. Although the debt would momentarily decrease after the Cold War, even running

a brief period of budget surpluses from 1998-2001, the national debt would reach $10.3 trillion

by the end of 2008, a little more than ten times the $907.7 Billion national debt number in 19801.

What Is National Debt?

National debt is defined as the amount of borrowed funds (debt) that is owed by the US

Government and the citizens of the USA. National debt is created when the federal budget runs

in a deficit. That means that the federal government spends more money than it earns in revenue2

. Revenue mostly comes from taxes but it includes any revenue generated from other sources.

There are two owners of national debt. The first owner is Public Debt. Public debt is debt that is

owed to the public (outside of the US Government). Public debt includes debt that is owed to

individuals, corporations, other governments (state, local and foreign), as well as hedge funds

1
United States Treasury Department. (2019). Historical Debt Outstanding-Our Debt. Retrieved from
https://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt_ourheritage.htm
2
Coolidge Foundation. (2019). Debate Brief-The National Debt. Retrieved from
https://www.coolidgefoundation.org/wp-content/uploads/2019/01/National-Debt-Brief-FINAL.pdf
and other institutional investors. The other owner is Intragovernmental Debt. Intragovernmental

debt is debt that is owed to other US Government agencies. The national debt is measured by

adding up the two components of the debt3. The current national debt is at $22.027 trillion

dollars4.

Positive Effects of the National Debt:

In an attempt to answer some of the questions outlined at the opening, let us examine the

potential positive effects on the economy the debt can have. Economic growth is always a

positive thing. One argument that some economists and politicians make is that you can’t reduce

the debt and grow the economy. This is one question we should examine: Can you grow the

economy even while reducing the national debt? Economists Carmen Reinhart of the University

of Maryland and Kenneth Rogoff of Harvard University make an argument that you can both

grow the economy and reduce the national debt. In their paper “Growth In A Time of Debt”, they

point out that in the 1920s, the US government both reduced the national debt and continued to

grow the economy. In the decade between 1920-1929, they point out that the US GDP grew 43%

while the national debt was reduced by 30% at the same time. They go onto note that even when

government expenditures got reduced, growth was still strong5.

The Coolidge Foundation examined the data that economists Reinhart and Rogoff

compiled and compared that data to the 1930s. They found that GDP grew by 20% (less than half

the rate of the 1920s) while the national debt exploded by 150%. That data lead them to an

3
Connally, J. (2019). Chapter 15- The National Debt Lecture. Given at Indiana University Southeast
4
United States Treasury Department. (2019). Public Debt Report. Retrieved from
https://www.treasurydirect.gov/NP/debt/current
5
Reinhart, C. and Rogoff, K. (2010). Growth In A Time Of Debt. National Bureau of Economic Research.
Retrieved from https://www.nber.org/papers/w15639.pdf
observational question; if debt reduction and economic growth truly have an inverse relationship,

how can one explain the debt reduction and economic growth of the 1920s with the debt growth

and lower economic growth of the 1930s6? That is a question I have yet to identify a clear

answer to.

What other positive effects are there? Since the United States operates on fiat currency,

currency without intrinsic value, the federal government possesses the ultimate power to create

currency in order to pay off creditors, therefore keeping interest rates low. Additionally, a large

federal debt indicates a stimulated economy, which means interest rates will continue to remain

low, and the loanable funds market will continue to expand. Lower interest rates directly

incentivize American taxpayers to invest their hard-earned funds in pursuit of a good return, and

banks can therefore lend invested money to other borrowers, continuing the cycle7.

Negative Effects of the National Debt:

Are there any negative effects the debt can have on the US economy as a whole? There

are some arguments that economists make that state that a nation holding debt over 90% of GDP

can harm us more than hurt us. One potential scenario that is pointed out is that as debt continues

to grow, it is typical for investors to demand higher interest rates in order to justify higher risk.

As the country continues to spend, risk levels become concerningly high and many begin to fear

defaulting. As fear of collapse (even if it’s not justified) begins to form, many will withdraw their

funds from banks and possibly trigger a collapse, as seen in 1929. Additionally, as United States

debt grows, larger payments are required to accommodate the interest alone. We’ve since learned

6
Coolidge Foundation. (2019). National Debt-The Debate Brief. Retrieved from
https://www.coolidgefoundation.org/wp-content/uploads/2019/01/National-Debt-Brief-FINAL.pdf

7
Spross, J. (4/5/2016). The Week. Why America’s Gigantic National Debt Is A Good Thing. Retrieved
from https://theweek.com/articles/618419/why-americas-gigantic-national-debt-good-thing
from the great depression and deposits are now FDIC insured, but that isn’t a complete safety

net. Large national debt harbors a general feeling of uncertainty in citizens, discouraging

investors and driving down consumption, lowering gross domestic product overall. Once foreign

investors believe the national debt has reached an “unmanageable” level, they’re more likely to

secure funds in other places rather than America, and therefore decrease the loanable funds

market overall, contributing to an overall downward sloping spiral.

Expanding on what we just discussed above, we see another view on that potential

negative to having so much national debt. The Mises Institute noted in October 2018 that interest

payments alone are starting to become one of the largest expenses in the national budget. They

note that the US Office of Management and Budget is predicting that between 2017-2020, debt

payment outlays in the national budget will increase 70%, outpacing defense spending which is

expected to consume 20% of the national budget. That itself wouldn’t be a problem if US

Government revenues rises in line with spending requirements. The Mises Institute goes onto ask

though, what happens in the case of recession? If a recession would occur, we’d likely see a

sharp decrease in revenues. They observed that during the Great Recession, in 2008, US revenue

fell 3% and fell 13% in 2009. If revenue would fall like that again during another economic

slowdown, Congress would have to begin the painful process of deciding where to cut spending

or to explode the deficits even higher. At that point, depending on the actions of the Federal

Reserve, and depending on how investors react to the actions of the Fed, we could see upward

pressure on interest rates to service US Debt8.

8
McMaken, R. (10/27/2018). Mises Institute. Deficits Do Matter: Debt Payments Will Consume Trillions of
Dollars In The Coming Years. Retrieved from
https://mises.org/wire/deficits-do-matter-debt-payments-will-consume-trillions-dollars-coming-years
What Would Happen If You Paid the National Debt Off Slowly?

What would happen if we paid off the debt slowly, over time? As noted above, we can

see that historically in 1835, Andrew Jackson, the president at the time, managed to fully pay off

United States debt, and not a lot actually happened. Jackson made paying off national debt his

personal mission, and was beyond determined to do it. Debt was briefly at $0, but it soon picked

right back up when more money was printed and banks offered competitive loans. It’s safe to

assume that the primitive nature of the economy at the time was a primary factor in the lack of

catastrophe, as today modern economists assume that quickly paying off the debt in its entirety

would cause a negative outcome and a domino effect because of how well-established the United

States has become in the global economy. If we were to pay off the United States debt slowly

over time, it would not cause nearly as much of a catastrophe, assuming we wouldn’t attempt to

pay it off completely. Healthy debt requires a middle ground, not too much, but not zero as well.

A manageable amount of debt is actually beneficial to the economy as it promotes spending and

investment in both the private sector and government. Healthy debt promotes low interest rates,

directy incentivizing the average American citizen to invest in the community around them,

continuing the wave of economic stimulus across the country. In addition to economic positivity,

the average taxpayer would see more of the tax revenue collected spent (hopefully) on improving

crumbling infrastructure and other various government projects , as smaller payments would be

required to manage current debt obligations.

What Would Happen If You Paid the National Debt Off Quickly?
 Conversely, what would happen if we paid the national debt off quickly, all at once?

Hypothetically, if the United States were to quickly pay off the national debt today in its entirety,

treasury bonds would cease to exist and faith would be lost in the security of United States debt.

Since the federal government uses treasury bonds in order to borrow money, the sudden halt of

ever-growing debt would signal the end of treasury bonds overall. This could cause a chain

reaction, triggering panic in investors both domestic and foreign, as the constant security and

credibility of our national debt is used in markets around the globe. In addition to affecting the

creditworthiness of the United States, inflation could be expected to significantly rise as well,

contributing to the overall domino effect9. Since the public often bases their reactions upon

what’s portrayed in the media, foreign investors losing faith in the security of the American

dollar could likely cause everyday citizens to avoid using financial institutions to secure their

funds, perhaps contributing to a downfall in the banking industry overall.

Stephanie Kelton, professor of Economics and Public Policy at Stony Brook University

and the Economic Advisor to 2016 Presidential Candidate Bernie Sanders, recently gave an

interview with CNBC on March 4, 2019, discussed the debt and the deficits in depth. While

professor Kelton acknowledges that the budget deficit matters, she argues the deficit can be too

big, evidenced by inflation. However she also argues the deficit can be too small to support

aggregate demand, as evidenced by unemployment. Her argument is a budget deficit is simply

the difference of what the Government spends into the economy subtracted by what it taxes back

out of the economy. That means if the US Government spends $100 dollars into the economy but

only tax $90 of it back out, while that is recorded as a deficit on the federal government’s books,

9
Unknown Author. (10/20/2011). National Public Radio. Life After Debt. Retrieved from
https://media.npr.org/assets/img/2011/10/20/LifeAfterDebt.pdf
we still have that $10 floating around in the economy somewhere by the deficit. The

Government’s deficits ultimately becomes a surplus for private households and businesses. In

response to the question of “Should you expand fiscal policy to boost growth?”, her argument is

that we need to maintain a balanced economy, with full employment and guard against an

acceleration of risk of inflation. She continues to argue that investing in education, infrastructure

and R&D are good ways to invest that although they increase deficits today, will lead to higher

growth in the future10.

When Mrs. Kelton was asked “How much debt is too much?”, she argues that it’s

impossible to put a number on that. She argues that Japan’s debt to GDP ratio is 240%, well

above where the US is projected to be now or in the future. She argues that Japan’s debt to GDP

ratio should show us that despite the size of the debt, there are no inflation problems and no

negative consequences. She points out that debt isn’t a burden on the next generation, rather that

the US Government bonds become the next generations assets. She closes her discussion on debt

by stating “the only potential risk to the national debt increasing over time is inflation, and to the

extent that you don’t believe the US Government has a long term inflation problem, you

shouldn’t believe the US has a long term debt problem.11”

Conclusion:

With all of this talk of the national debt, federal budget spending and deficits, you’re

probably wondering “is the national debt such a big deal?” With all of the evidence in our paper,

10
Kelton, S. (2019, March 4). Bernie Sanders’ 2016 Advisor on Trump’s Economy and Modern Monetary
Theory. Interview by CNBC. Retrieved from https://youtu.be/7cho7naef_k

11
Kelton, S. (2019, March 4). Bernie Sanders’ 2016 Advisor on Trump’s Economy and Modern Monetary
Theory. Interview by CNBC. Retrieved from https://youtu.be/7cho7naef_k
I hope you have enough info to take forward and add your own research to ours, so that you can

formulate your own opinion. We must remember though that as the Mises Institute points out,

“What might actually happen as the economy slows will be very difficult to guess since it's

impossible to know how the central banks of the world will react. But, we do know that any

combination of falling revenue and rising interest rates will lead to a situation in which federal

programs will either face real cuts — or the central bank will need to enact a new wave of

money-supply inflation necessary to cover the federal revenue shortfall without allowing interest

rates on government debt to rise dramatically.12” That is just one more thing to keep in mind when

making our decision on whether to add to the debt or not.

Bibliography:

1. United States Treasury Department. (2019). Historical Debt Outstanding-Our Debt. Retrieved
from https://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt_ourheritage.htm
2. Coolidge Foundation. (2019). Debate Brief-The National Debt. Retrieved from
https://www.coolidgefoundation.org/wp-content/uploads/2019/01/National-Debt-Brief-FINAL.pdf
3. Connally, J. (2019). Chapter 15- The National Debt Lecture. Given at Indiana University
Southeast
4. United States Treasury Department. (2019). Public Debt Report. Retrieved from
https://www.treasurydirect.gov/NP/debt/current
5. Kenton, W. (2018). Investopedia. Chicago School. Retrieved from
https://www.investopedia.com/terms/c/chicago_school.asp
6. Chappelow, J. (2018). Investopedia. Keynesian Economics. Retrieved from
https://www.investopedia.com/terms/k/keynesianeconomics.asp
7. Reinhart, C. and Rogoff, K. (2010). Growth In A Time Of Debt. National Bureau of Economic
Research. Retrieved from https://www.nber.org/papers/w15639.pdf
8. Spross, J. (4/5/2016). The Week. Why America’s Gigantic National Debt Is A Good Thing.
Retrieved from
https://theweek.com/articles/618419/why-americas-gigantic-national-debt-good-thing
9. McMaken, R. (10/27/2018). Mises Institute. Deficits Do Matter: Debt Payments Will Consume
Trillions of Dollars In The Coming Years. Retrieved from
https://mises.org/wire/deficits-do-matter-debt-payments-will-consume-trillions-dollars-coming-year
s
10. Unknown Author. (10/20/2011). National Public Radio. Life After Debt. Retrieved from
https://media.npr.org/assets/img/2011/10/20/LifeAfterDebt.pdf
11. Kelton, S. (2019, March 4). Bernie Sanders’ 2016 Advisor on Trump’s Economy and Modern
Monetary Theory. Interview by CNBC. Retrieved from https://youtu.be/7cho7naef_k

12
McMaken, R. (10/27/2018). Mises Institute. Deficits Do Matter: Debt Payments Will Consume Trillions
of Dollars In The Coming Years. Retrieved from
https://mises.org/wire/deficits-do-matter-debt-payments-will-consume-trillions-dollars-coming-years
12. Summers, L. (2019, March 5). Larry Summers: Modern Monetary Theory is A Recipe For
Disaster. Interview by C. Quintanilla and S. Eisen. Squawk on the Street. New York: CNBC