The Federal Government Debt: Its Size and
Economic Significance
Brian W. Cashell
Specialist in Macroeconomic Policy
February 3, 2010
Congressional Research Service
7-5700
www.crs.gov
RL31590
CRS Report for Congress
P
repared for Members and Committees of Congress
The Federal Government Debt: Its Size and Economic Significance
Summary
After several years of surpluses in the late 1990s, the federal budget has been in deficit since
FY2001. Deficits represent the additional borrowing required in each year to bridge the gap
between tax revenues and spending outlays. Each deficit adds to the already existing stock of
outstanding federal debt.
Some of those deficits may have seemed large at the time, but the budget deficit for FY2009 was
unprecedented, in dollar terms, and the FY2010 deficit is also expected to be much larger than
those of past years. The prospect of such rapid growth in the federal debt may seem alarming, and
some might wonder how much the debt can grow before it poses significant economic risks.
In a slack economy, federal borrowing and spending can stimulate growth in output in the short
run. As the economy approaches full employment, federal government borrowing adds to total
credit demand and tends to push up interest rates. Higher interest rates increase the cost of
financing new investment in plant and equipment and thus may tend to reduce the stock of
productive capital below what it might otherwise have been. That would tend to reduce the long-
run rate of growth.
In the long run, the relationship between the growth rate of the federal debt and the overall rate of
economic growth is critical to economic stability. As long as the debt grows more rapidly than
output, the ratio of debt to gross domestic product (GDP) will rise. Debt growth in excess of
economic growth is ultimately unsustainable. Whether the debt-to-GDP ratio is on such a path
depends on the size of the budget deficit, the rate of interest, and the rate of growth in GDP.
What matters most, as far as economic stability is concerned, is what investors believe to be the
long-run outlook for the debt-to-GDP ratio. If large deficits are expected to persist, or if the
interest rate on the debt is expected to exceed the growth rate indefinitely, then at some point the
federal government may begin to find it more difficult to sell new securities.
Should the federal government be unable to find private sector buyers, the Federal Reserve might
buy Treasury securities in order to sustain their marketability. Should it decide to do so, then the
threat is no longer one of government insolvency, but rather of inflation.
Congressional Research Service
The Federal Government Debt: Its Size and Economic Significance
Contents
Introduction ................................................................................................................................ 1
Measuring the Federal Debt ........................................................................................................ 1
Recent History of the Federal Debt.............................................................................................. 2
The Short- and Long-Run Effects of Federal Borrowing.............................................................. 3
Who Owns the Federal Debt?...................................................................................................... 4
The Relationship Between Federal Debt and GDP....................................................................... 6
What are the Risks of Rising Federal Debt?................................................................................. 7
Government Debt in Other Industrialized Countries .................................................................... 9
Conclusion................................................................................................................................ 10
Figures
Figure 1. Federal Debt Held by the Public ................................................................................... 3
Figure 2. Ownership of the Gross Federal Debt, June 2009.......................................................... 5
Figure 3. Economic Growth and Interest on the Federal Debt ...................................................... 6
Figure 4. The Budget Deficit and Net Interest Outlays................................................................. 7
Tables
Table 1. Major Foreign Holders of Treasury Securities as of November 2009 .............................. 5
Table 2. Gross General Government Debt as a Percentage of GDP ............................................ 10
Contacts
Author Contact Information ...................................................................................................... 11
Congressional Research Service
The Federal Government Debt: Its Size and Economic Significance
Introduction
After several years of surpluses in the late 1990s, the federal budget has been in deficit since
FY2001. Deficits represent new borrowing required in each year to bridge the gap between tax
revenues and spending outlays. Each deficit adds to the already existing stock of outstanding
federal debt.
Some of the deficits in recent years may have seemed large at the time, but the budget deficit for
FY2009 was unprecedented, in dollar terms, and the deficit in FY2010 is expected to be
considerably larger than in past years as well. The prospect of such rapid growth in the federal
debt may seem alarming, and some might wonder how large, or how rapidly, the debt might grow
before it poses significant economic risks.
One way in which policymakers have expressed their concerns over the level of federal
government debt is in the form of a statutory debt limit.1 Although the debt limit tends to rise as
necessary, those increases serve as occasions to consider the debt itself separately from the
policies that account for it.
There is more than one measure of federal debt, and that may be a source of confusion. This
report explains the different measures of the U.S. government debt, discusses the historical
growth in the debt, identifies the current owners of the debt, presents comparisons with
government debt in other countries, and examines the potential economic risks associated with a
growing federal debt.
Measuring the Federal Debt
The statutory debt limit is a ceiling set by Congress restricting the total amount of federal debt
outstanding. Gross federal debt, with some minor adjustments, is the measure that is subject to the
limit.
Although gross federal debt is the broadest measure of the debt, it may not be the most important
one. Not all of the gross debt actually represents past borrowing in credit markets. Some of the
debt is held by the so-called trust funds, primarily the one for Social Security, but also others such
as unemployment insurance, the highway trust fund, and one for federal employee pensions.
Relatively small amounts of debt are also held by selected federal agencies.
The assets held by the trust funds consist entirely of non-marketable federal debt. That debt exists
only as a bookkeeping entry, and does not reflect past borrowing in credit markets. The trust fund
balances represent the cumulative amount that the government has not had to borrow in credit
markets since they were simply credited to the trust fund accounts.2
The debt measure that is relevant in an economic sense is debt held by the public. This is the
measure of debt that has actually been sold in credit markets, and which has influenced interest
1 CRS Report RL31967, The Debt Limit: History and Recent Increases, by D. Andrew Austin and Mindy R. Levit.
2 Interest paid on the trust fund accounts is also strictly a bookkeeping entry and does not constitute an actual outlay of
the federal government.
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The Federal Government Debt: Its Size and Economic Significance
rates and private investment decisions. At the beginning of calendar 2010, the debt held by the
public was $7.8 trillion, whereas total gross federal debt was $12.3 trillion.
The dollar amount of the debt, however large it may seem to be, is not the best measure of its
burden on the economy. Just as an individual with a larger income can afford to take on more
debt, the importance of the debt can only be measured relative to the overall size of the economy.3
For a given amount of debt, the larger the potential tax base is, the less of a burden on the
economy the interest payments on that debt will be. The most common way of putting the size of
the debt in perspective is to express it as a percentage of total gross domestic product (GDP).
Recent History of the Federal Debt
Prior to World War II, the federal budget was in surplus about as often as it was in deficit. Some
of the largest increases in the debt resulted from wartime spending. There were large increases in
the debt held by the public related to the Civil War and also to World War I. Since World War II,
the federal budget has been in deficit most of the time and the debt has steadily grown. Since
1940, revenues exceeded outlays in only 12 years.4
Figure 1 shows gross federal debt held by the public since 1940. The red line plots the dollar
value of the debt held by the public since 1940. These are nominal amounts (i.e., they have not
been adjusted for inflation). The black line shows the debt held by the public as a percentage of
GDP.
The dollar value of the debt rose gradually until the late 1970s and early 1980s, at which time its
growth accelerated. It peaked in 1997, fell through 2001, but since then has reached a new high
each year. Measuring the debt relative to GDP tells a different story. The surge in debt to finance
the costs of World War II is much more pronounced and indicates that recent debt levels are far
from unprecedented, in terms of the burden to the economy. Following that surge and until the
late 1970s, however, debt grew much less rapidly than did the overall economy and so the ratio
fell steadily. Between 1980 and 1995, the debt grew more rapidly than the economy so the ratio
rose. Between 1995 and 2001, with the decline in debt levels, the ratio fell. Between 2002 and
2005, it rose again, but then fell in 2006 and 2007 even with significant deficits. It is above the
recent peak reached in 1993 but, for now, it is below what it was in 1955. Given current
projections the debt-to-GDP ratio seems likely to continue to rise over the next few years.
3 Prospects for economic growth may also affect perceptions about the advisability of taking on more debt.
4 See also CRS Report RL34712, Ebbs and Flows of Federal Debt, by Mindy R. Levit.
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The Federal Government Debt: Its Size and Economic Significance
Figure 1. Federal Debt Held by the Public
120.0
8
7
100.0
Left scale
6
P
Right scale
rs
D
80.0
la
5
f G
dol
t o
60.0
4
of
rcen
3
ons
e
40.0
li
P
il
2
Tr
20.0
1
0.0
0
1940
1950
1960
1970
1980
1990
2000
Source: Congressional Budget Office.
The Short- and Long-Run Effects of Federal
Borrowing
In the short run, growth in the public debt (i.e., budget deficits) affects the composition of
economic output. When there is considerable slack in the economy, the main effect of an increase
in the deficit may be to stimulate demand and raise output. That’s the reasoning behind the fiscal
stimulus in the American Recovery and Reinvestment Act of 2009 (P.L. 111-5).
Eventually, however, as the economy approaches full employment, and credit markets tighten,
federal government borrowing tends to push up interest rates. Higher interest rates increase the
cost of financing new investment in plant and equipment and thus may tend to reduce the stock of
productive capital below what it might otherwise have been. Thus, there may be a shift in the
composition of output towards consumption and away from investment. Consumption that might
otherwise have been deferred (i.e., saving) is reduced and current consumption rises.
The higher interest rates may also have an effect on international capital flows, and thus on the
trade balance. Other things being equal, they make dollar-denominated assets more attractive to
foreign investors because of the relatively higher yield. Foreign investors, in order to buy U.S.
securities, must first buy dollars with which to pay for them. The increased demand for dollars in
exchange markets tends to push up the price of the dollar in terms of other currencies.5
5 In the current international economic environment a desire for quality investments may also affect capital flows. See
CRS Report R40007, Financial Market Turmoil and U.S. Macroeconomic Performance, by Craig K. Elwell.
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The Federal Government Debt: Its Size and Economic Significance
The increase in the exchange value of the dollar has two mutually reinforcing effects. First, the
price of imported goods falls because it takes fewer dollars to buy the same quantity of goods and
services abroad. Lower prices for imported goods means, other things being equal, that U.S.
consumers spend more on goods and services produced abroad. Second, the price of U.S.-
produced goods and services rises for foreigners because the amount of foreign currency required
to buy a given quantity of U.S. exports rises. Because U.S. exports are more expensive, they tend
to decline.
Both the rise in imports and the drop in exports contribute to a larger trade deficit. Because of the
increased domestic borrowing associated with the rising federal debt, firms that sell a significant
share of their production abroad, and those that compete directly with foreign firms selling in the
United States, experience a drop in the demand for their goods and services. The increased capital
inflow, however, may offset to some extent the reduction in investment that might otherwise
result from the increase in domestic credit demand.6
Who Owns the Federal Debt?
Because Treasury securities are seen as relatively safe, they are held by a wide range of investors.
Next to cash they are the most liquid asset, meaning they can easily be converted to cash when
necessary, on short notice. Because of that, investors hold them as a way of managing the overall
risk associated with their portfolios.
Figure 2 shows a breakdown of the holders of the outstanding gross federal debt. The U.S.
government is itself the largest holder of the debt, mainly in the trust funds. Included in the
“other” category are financial institutions, including banks, insurance companies, and mutual
funds, as well as private pension funds. The Federal Reserve holds a significant share of the debt.
The Federal Reserve buys and sells Treasury securities in its open market operations in order to
manage short-term interest rates.7 State and local governments hold Treasury securities as well,
mainly in pension funds for their employees. Foreign investors hold 29.3% of the debt.
The Treasury Department publishes estimates of major foreign holdings of Treasury securities.
Mainland China, Japan, and the United Kingdom are the three largest holders. Table 1 presents
recent data for countries with the largest holdings of Treasury securities.
6In the longer run, as the amount of foreign holdings of U.S. assets increases, an increasing share of U.S. income will
flow abroad in the form of interest, dividend, and rent payments. While this outflow does not necessarily mean a
decline in U.S. living standards, it may mean that future living standards will not be as high as they would have been if
a greater share of domestic investment had been financed by borrowing at home instead of abroad.
7 Recently the share of Treasury securities held by the Federal Reserve has fallen. In an effort to add liquidity to credit
markets, the Federal Reserve has swapped substantial amounts of Treasury securities for relatively riskier assets that
were held by other financial institutions. See CRS Report RL34427, Financial Turmoil: Federal Reserve Policy
Responses, by Marc Labonte.
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The Federal Government Debt: Its Size and Economic Significance
Figure 2. Ownership of the Gross Federal Debt, June 2009
Federal
Reserve
6.5%
U.S.
Other privately
Government
held
37.8%
21.8%
State and local
Foreign
government
investors
4.6%
29.3%
Source: Department of the Treasury.
Table 1. Major Foreign Holders of Treasury Securities as of November 2009
Country
Holdings (billions of dollars)
Percentage of Foreign Held Debt
Total Foreign Held
3,597.5
100.0
Mainland China
789.6
21.9
Japan 757.3 21.1
United Kingdom
277.5
7.7
Oil Exporters
187.7
5.2
Caribbean Banking Centers
179.8
5.0
Brazil 157.1 4.4
Hong Kong
146.2
4.1
Russia 128.1 3.6
Luxembourg 91.7
2.5
Taiwan 78.4 2.2
Switzerland 63.0
1.8
Germany 53.6
1.5
Source: Department of the Treasury; Federal Reserve Board.
Notes: Oil Exporters include Ecuador; Venezuela; Indonesia; Bahrain; Iran; Iraq; Kuwait; Oman; Qatar; Saudi
Arabia; the United Arab Emirates; Algeria; Gabon; Libya; and Nigeria.
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The Federal Government Debt: Its Size and Economic Significance
The Relationship Between Federal Debt and GDP
In the long run, the relationship between the growth rate of the federal debt and the overall rate of
economic growth is critical to economic stability. As long as the debt grows more rapidly than
output, the ratio of debt to GDP will rise. Perpetual debt growth in excess of economic growth is
inherently unsustainable.
Whether the debt-to-GDP ratio is on such a path depends on the budget deficit, of course, but also
on the rate of interest and the rate of growth in GDP.8 To illustrate, consider the case where the
budget is balanced except for the interest payment on the debt. In other words, the budget deficit
is equal to the interest payment. In this case, the debt would grow each year by an amount equal
to the interest cost of financing the debt. Thus, the growth rate of the debt would equal the interest
rate. If the interest rate were higher than the growth rate of GDP, then the debt would grow faster
than GDP and the ratio of debt to GDP would rise. If, instead, the interest rate stays below the
economic growth rate, then the ratio of debt to GDP would fall.
Figure 3 compares the average interest rate on the federal debt with the growth rate of nominal
GDP. This measure of economic growth reflects changes in both real output and inflation. The
green line shows the annual growth rate of nominal GDP, and the red line shows the average
interest rate on the outstanding federal debt held by the public.
Figure 3. Economic Growth and Interest on the Federal Debt
30
25
Growth rate
20
t
n 15
e
c
10
Per
5
0
Interest rate
-5
1940
1950
1960
1970
1980
1990
2000
Source: Department of Commerce, Bureau of Economic Analysis; Congressional Budget Office.
For most of the period between 1940 and 1980, the interest rate remained well below the growth
rate of the economy. For much of the past 25 years, however, the interest rate has been above the
growth rate, which through the mid-1990s contributed to the rising debt-to-GDP ratio. If the
8 In the current discussion, both the growth rate and the interest rate are nominal (i.e., not adjusted for inflation).
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The Federal Government Debt: Its Size and Economic Significance
interest rate is less than the growth rate, it is possible for the debt ratio to fall even with a modest
budget deficit. When the interest rate is above the growth rate, a surplus is required to keep the
debt-to-GDP ratio from rising.
Consider the case where the budget deficit is larger than the interest payment on the debt. When
the budget deficit is larger than the interest payment, the difference between the two is sometimes
referred to as the “primary” deficit. In that case, the growth rate of the debt would be larger than
the interest rate, and so, even with an interest rate below the GDP growth rate, the debt-to-GDP
ratio could still rise. Figure 4 shows the relationship between the budget deficit and the interest
payment on the debt from 1940 through 2009. The black line shows the deficit (which in some
cases is negative, i.e., a surplus), and the red line shows the interest payment.
Figure 4. The Budget Deficit and Net Interest Outlays
1600
1400
1200
rs 1000
a
800
Doll
600
Interest
of
payment
400
lions
200
Bil
0
-200
Budget
deficit
-400
1940
1950
1960
1970
1980
1990
2000
Source: Congressional Budget Office.
Although there were clearly exceptions, the overall pattern until recently was for the budget
deficit and the interest payment to rise in tandem, which is not surprising since the deficits
represents additional debt which requires a larger interest payment. In the late 1990s, when the
budget was in surplus (i.e., a negative deficit), the budget deficit was clearly substantially less
than the interest payment which contributed to the decline in the debt-GDP ratio. Since FY2003
that situation has reversed, and except for FY2007 the deficit has been larger than the interest
payment.
What are the Risks of Rising Federal Debt?
The federal government usually has little difficulty in marketing securities when revenues fall
short of outlays. As long as there is a ready market for federal debt, the risks are small.
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The Federal Government Debt: Its Size and Economic Significance
What matters most, as far as economic stability is concerned, is what investors believe the long-
run trend in the debt-GDP ratio to be. If large primary deficits (deficits in excess of the net
interest payment) are expected to persist, or if the interest rate on the debt is expected to exceed
the growth rate indefinitely, then at some point the federal government may find it more and more
difficult to sell new securities. In other words, it may become harder for the federal government
to find willing lenders to finance its deficits. At worst, private investors might come to doubt the
federal government’s ability even to meet its interest payments, and would be reluctant, if not
completely unwilling, to hold government bonds.
Inability to borrow money in credit markets can be fatal to private businesses. Firms that are
losing money and cannot find willing lenders are on the road to bankruptcy. The federal
government, however, has a source of credit not available to individual businesses, the Federal
Reserve Bank.
There are two possible outcomes should the federal government be unable to find private sector
buyers, either domestic or foreign, for its securities. First, the federal government could simply
find itself unable to meet all of its obligations. In that case outlays would have to fall unless taxes
were increased enough to eliminate the shortfall. Second, rather than allow the government to
default, the Federal Reserve might buy sufficient Treasury securities in order to sustain their
marketability.9
Although subject to congressional oversight, the Federal Reserve is independent and under no
legal obligation to ensure the sale of government securities. But should it decide to do so, then the
threat is no longer one of government insolvency, but rather of inflation.
When the Federal Reserve buys Treasury securities, it increases the stock of reserves to
commercial banks. Those increased reserves, in turn, increase the banks’ capacity to lend money
and create demand deposits, increasing the stock of money in circulation. The historical record
demonstrates that continued financing of large government budget deficits by “printing money”
runs a substantial risk of rapidly accelerating inflation.
Current and projected federal debt, however, are both short of the levels thought to be associated
with this risk. For the moment, federal debt remains well below the level it reached following
World War II.
History provides a number of examples where large public sector debt led to serious economic
consequences. In the aftermath of World War I, four countries experienced episodes of rapid
inflation directly attributable to the central bank financing of very large budget deficits through
money creation: Germany, Poland, Austria, and Hungary. In each of these cases, more than one-
half of the total central government expenditures was deficit financed. As a result, the public lost
confidence in the governments’ ability to bring growth in public sector debt under control by
either raising taxes or cutting expenditures.10
9 By law (section 14(b) of the Federal Reserve Act), the Federal Reserve can only buy Treasury securities in the open
market. It cannot buy them directly from the Treasury.
10Thomas J. Sargent, “The Ends of Four Big Inflations,” in Robert Hall, ed., Inflation: Causes and Effects (National
Bureau of Economic Research, 1982), pp. 41-97.
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Immediately following World War II, Hungary experienced the most extreme episode of inflation
on record. Between July 1945 and August 1946, the price level in Hungary rose by a factor of 3 x
1025. As is characteristic of instances of very rapid inflation, tax revenues fell far short of public
expenditures during this time. For much of the period, revenues covered less than 10% of total
expenditures.11
During the mid-1980s, Bolivia experienced an episode of very rapid inflation. In 1984, general
government revenues represented less than 20% of total government expenditures, and the budget
deficit surpassed 20% of GDP. Annual inflation in 1984 was over 1,000%, and in 1985 the
inflation rate topped 11,000%.12
These are all examples of extreme cases, but they serve to put the U.S. experience in perspective.
Even in instances of much more modest federal government credit demand, there remains the
possibility that the Federal Reserve might seek to mitigate any upward pressure on interest rates
due to the Treasury’s borrowing needs at the risk of pushing up the inflation rate. But as long as
the Treasury can find buyers for its securities in private credit markets, the Federal Reserve will
likely find it easier to pursue an anti-inflationary policy.
In any country with a large government debt there may be temptation to reduce the real value of
that debt with inflation. In cases where that is perceived to be a real possibility, nominal interest
rates may be higher than they otherwise would be because investors demand a higher rate of
return to protect themselves from the possible decline in the value of their assets. The
independence of the Federal Reserve is generally believed to reduce the possibility that will
happen.13
Government Debt in Other Industrialized Countries
Short of the extreme examples cited in the previous section, it is useful to compare the federal
government debt in the United States with that of other developed countries. The United States is
not the only country whose central government has issued a significant amount of debt.
Among the countries shown in Table 2 are all those participating in the European Economic and
Monetary Union (EMU). These are the countries who now use the Euro as their currency. The
Maastricht Treaty established conditions for European Union countries’ participation in the EMU.
Among them was the condition that a member country’s public sector financial condition must be
“sustainable.” In particular, the standards for assessing the sustainability of public sector finances
were that the public sector deficit not exceed 3% of GDP, and that the public sector debt not
exceed 60% of GDP. More than half of the Euro countries now have debt-to-GDP ratios above
60%.
11 William A. Bomberger and Gail E. Makinen, “The Hungarian Hyperinflation and Stabilization of 1945-1946,”
Journal of Political Economy, vol. 91, no. 5 (1983), pp. 801-824.
12 Juan-Antonio Morales, “Inflation Stabilization in Bolivia,” in Michael Bruno et. al., eds., Inflation Stabilization (MIT
Press, 1988), pp. 307-346.
13 See CRS Report RL31056, Economics of Federal Reserve Independence, by Marc Labonte.
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As the figures in Table 2 indicate, the United States is far from having the largest government
debt. Of the 17 countries shown, five had a higher debt-to-GDP ratio in 2009 than did the United
States. Twelve countries increased their debt ratio between 2000 and 2009. Four of the countries
had public debt larger than their GDP in 2009.
Table 2. Gross General Government Debt as a Percentage of GDP
Country 2000
2009
Austriaa 71.1
72.9
Belgiuma 113.8
101.2
Canada 82.1
82.8
Finlanda 52.3
43.7
Francea 65.6
84.5
Germanya 60.4
77.4
Greecea 114.9
114.9
Irelanda 40.2
65.8
Italya 121.0
123.6
Japan 135.4
189.3
Luxembourga 9.2
18.2
Netherlandsa 63.9
71.4
Portugala 62.0
83.8
Spaina 66.5
59.3
Switzerland 52.5
44.4
United Kingdom
45.1
71.0
United States
54.4
83.9
Source: Organization for Economic Co-operation and Development.
a. Member of the European Economic and Monetary Union (Euro country).
Conclusion
It appears that the federal debt is likely to rise significantly in the near future. The Congressional
Budget Office now projects the budget to be in deficit through 2020. In the current economy,
however, there is significant slack and debt growth is likely to affect aggregate demand much
more than prices or interest rates.
At current and even at projected levels, most economists would agree the debt poses little
immediate risk to economic stability. But continued deficits on the order of 10% of GDP
eventually might, and are likely unsustainable. Ultimately the risk of a very large, and rapidly
growing, government debt is extremely high rates of inflation, as pressure would mount on the
Federal Reserve to monetize the debt.
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Author Contact Information
Brian W. Cashell
Specialist in Macroeconomic Policy
bcashell@crs.loc.gov, 7-7816
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