The Debt Is About to Matter Again
In 2019, Lawrence Summers and Jason Furman, two of America’s most influential economists, published an essay titled “Who’s Afraid of Budget Deficits?” In it, they argued that Washington’s long-standing worries about the national debt had been overblown. Other prominent experts, including the former head economist of the International Monetary Fund, an institution known for imposing harsh fiscal austerity on developing countries, came to similar conclusions. The reason: Deficit hawks had been fixated on the wrong number.
The debt, according to these economists, still mattered. But whether it would become a serious problem, they observed, depended not on how big and scary the number was (about $28 trillion at the time, and today closer to $36 trillion), but instead on a simple formula involving the variables r and g. As long as a country’s economic growth rate (g) is higher than the interest rate (r) it pays on its national debt, then the cost of servicing that debt will remain stable, allowing the government to roll it over indefinitely without much worry. Given that interest rates had been close to zero for a decade, Furman and Summers concluded that the “economics of deficits have changed” and called on Washington to “put away its debt obsession and focus on bigger things.”
[Annie Lowrey: The Republican’s budget makes no sense]
But what was true then is true no longer. The combination of Donald Trump’s growth-inhibiting tariff crusade and the GOP’s deficit-exploding tax bill is likely to push the relationship between r and g into extremely dangerous territory. “In a short amount of time, the fiscal picture has gone from comfortably in the green-light region to the red-light region,” Summers recently told me. In other words, now would be a very good time for Washington to bring back its debt obsession.
The “debt doesn’t matter” consensus had a strong start. During the coronavirus pandemic, Congress spent trillions of dollars to keep the economy on life support without worrying about paying for it. The U.S. debt load reached new heights, but interest rates continued to fall. No bond vigilantes or debt spirals were to be seen.
In the years to follow, however, the Fed raised interest rates dramatically in an effort to tame inflation. As a result, government payments on debt interest soared to $881 billion in 2024, more than the United States spent on either Medicaid or national defense. The same economists who had helped usher in the new debt consensus, including Summers and Furman, began warning that America’s fiscal picture had become concerning. Even so, the situation was far from a crisis. A post-pandemic economic boom had kept the relationship between g and r on a stable trajectory, and in the fall of 2024, with inflation waning, the Fed began to lower interest rates.
Then Donald Trump took office and threw the world economy into chaos.
The interest rate on government debt is ultimately determined by investors’ confidence that the U.S. will eventually pay it back. (When fewer people want to buy your debt because they view it as excessively risky, you have to offer a higher return.) The mere possibility of a global trade war and a huge, unpaid-for tax cut has shaken that confidence. Last week, Moody’s, one of the world’s major credit agencies, downgraded America’s credit rating from its premium Triple-A status, causing interest rates on long-term government bonds to rise to near their highest point in two decades (above even the “yippy” level that prompted Trump to recall his “Liberation Day” tariffs). Rates surged again yesterday morning, when House Republicans narrowly passed a version of their tax bill that would add more than $3 trillion to the deficit over the next decade. If Trump signs that bill into law while expanding his global trade war, then investors may choose to dump their U.S. Treasury holdings en masse, causing interest rates to spike even higher. “For years, we lived in a world where there was basically zero risk premium on U.S. debt,” Jared Bernstein, the former head of Joe Biden’s Council of Economic Advisers, told me. “In four short months, Team Trump has squandered that advantage.”
[David A. Graham: Congressional Republicans vs. reality]
Rising interest rates might not be such a big issue if Trump’s policies were simultaneously supercharging America’s economic growth, so that g stayed ahead of r. Instead, almost every credible growth forecast this year has fallen significantly in response to those policies. With Trump proposing new tariffs seemingly at random—including, just this morning, a 50 percent tariff on the European Union and a 25 percent tariff on all imported Apple products—businesses face paralyzing levels of uncertainty, a fact will likely drag down growth even further. Meanwhile, congressional Republicans claim that the massive tax cuts promised in their budget reconciliation bill will spur an economic boom, but several independent analyses have found that they will hardly affect growth at all, let alone enough to overcome the negative impact of tariffs. In fact, many economists warn that the U.S. economy could be headed for something akin to 1970s-style stagflation.
In normal times, the Federal Reserve could step in and mitigate both of these problems by cutting interest rates to boost growth or buying up Treasuries to quell financial-market panic. That is highly unlikely, however, when the central bank is also worried about the possibility that both the tax bill and Trump’s tariffs could set off an inflationary spiral. In the past week, multiple members of the Federal Reserve’s rate-setting body have signaled that it is unlikely to lower interest rates for the time being.
This confluence of rising interest rates and slowing growth is the exact set of circumstances capable of turning America’s national debt into a genuine crisis. When r remains higher than g for a sustained period of time, a vicious cycle emerges. Rising debt-servicing costs force the government to borrow more money to make its payments; investors, in turn, demand even higher interest rates, which pushes debt-servicing costs even higher, and so on.
In the best-case scenario, this process unfolds gradually, and the consequences are painful but not catastrophic. As more and more of the government budget is diverted to finance ever-growing debt-servicing costs, less room will be left to fund key social programs and productive investments; higher interest rates will mean less business investment and slower growth; and the government will be less capable of responding to a future economic crisis that requires heavy spending.
If, however, the debt snowball were to gather momentum quickly, the damage could be far worse. Investors might conclude that U.S. debt is no longer a safe investment, causing the equivalent of a bank run on the Treasury market as investors rush to sell their bonds for cash. Once that kind of psychological panic sets in, anything can happen. “This scenario is more serious than 2008,” Adam Tooze, an economic historian who wrote the definitive history of the financial crisis that triggered the Great Recession, argued recently on his Substack. “At some point, everything just goes parabolic,” Mark Zandi, the chief economist at Moody’s Analytics, told me. “That’s when parts of the financial system might start to break.”
A version of this happened in the United Kingdom in 2022, when then–Prime Minister Liz Truss unveiled a tax-cut proposal that would have blown up the country’s budget deficit. Bond markets freaked out, long-term interest rates soared, the pound plunged, and the entire British financial system appeared to be on the verge of collapse. The crisis ended only when the budget was scrapped and Truss was removed to restore confidence.
Until recently, the prospect of something so dramatic happening in the United States seemed exceedingly remote. Then, on April 9, Trump’s Liberation Day tariffs went into effect and the American bond market nearly melted down, stabilizing only after Trump paused most of the tariffs. If something similar happened again—say, in response to the final passage of the Republican tax bill—averting a sustained panic might not be so easy. The U.S. would be left with terrible choices: Impose painful austerity measures to reassure the market, default on the debt (which would likely trigger a severe, possibly global economic crisis), or print money to pay it off (which would trigger rampant inflation).
None of these possibilities appears to concern Trump and his allies in Congress, who are barreling forward with their agenda, warnings be damned. Perhaps they are betting that economists, who for so long predicted debt crises that never materialized, will be wrong one more time. That is a very high-stakes gamble indeed.