If inflation ever gets out of control, it’s easier to deal with it in a lower-debt environment.
High levels of debt are problematic.
- Growing debt means growing spending, along with the government expanding in size and scope.
- Generally, such spending crowds out the private sector. This dispels the hope that more spending will produce economic wonders.
- Deficit spending will eventually result in higher taxes for future generations which is an unfair burden.
- Debt is expansive in and of itself, as interest payments on an enormous amount of debt, even when interest rates are low, will result in a larger and expanding deficit.
- Eventually, growing debt will also slow economic growth which means fewer innovations, lower wage growth, and higher unemployment, which is very bad news.
- Finally, higher debt can result in a debt crisis.
Recent concerns over inflation have highlighted one additional reason why higher debt is problematic. Because, when it comes to inflation, people’s expectations about the price trajectory in the next few years are what really matters. If people believe that inflation is here to stay, which I believe is starting to happen, they will try to protect themselves from it NOW, and we will indeed have inflation sooner than later.
Under that scenario, to get inflation under control, the Federal Reserve will have to raise interest rates. And this is where federal debt levels really matter. Higher interest rates result in a large increase in overall interest payments fairly quickly, as so much of our debt needs to be rolled over on a short-term basis. A sudden increase in interest rates would slow down the recovery, too, which hurts lower-income Americans.