- The US isn’t in a debt crisis, but it’ll soon be facing the problem of its $31 trillion debt, Paul Krugman said.
- The debt was taken on to prop up the economy in tough times, and was often needed to avoid a severe recession.
- But the economy could have “a lot” of problems if tries to pay off that balance in a low-interest rate environment, he warned.
The US not in a debt crisis, but the country could still be facing a lot of economic problems when it tries to pay off the huge amount of debt its accumulated over the years, according to top economist Paul Krugman.
The Nobel laureate pointed to the US’s mounting fiscal concerns as it hit the $31.4 trillion debt limit set by Congress last week. That’s the largest debt balance of any country, and it forced the US Treasury to implement “extraordinary measures” and shift around federal funds to avoid default – which could be catastrophic for the economy, Treasury Secretary Janet Yellen warned.
The measures will last until June, when lawmakers could decide to raise the debt ceiling. Several economists, like “Dr. Doom” Nouriel Roubini, have raised alarm that the US could be entering a debt crisis as frenzied household, government, and institutional borrowing over the last decade finally takes its toll.
But we’re not in a crisis yet, Krugman said in an op-ed for the New York Times on Tuesday.
“We are not in any kind of debt crisis. Historically, in fact, US debt isn’t all that unusual,” he said, noting that economies typically take on more debt when major events strike, like war, severe recessions, and pandemics.
That justifies much of the US’s debt balance, since most of what was borrowed was taken out during the Great Recession, when the economy suffered from the bust of the housing bubble, and during the COVID-19 pandemic, when economic activity was crushed by lockdown measures. In both cases, borrowed money was spent as stimulus, keeping the economy afloat and preventing a potential repeat of the Great Depression, Krugman said.
But a side of effect of that stimulus is higher inflation, a problem central bankers are now scrambling to solve by hiking interest rates and draining markets of liquidity. Fed officials aggressively hiked rates and started rapidly reducing the size of its balance sheet last year. Now, inflation now appears to be easing, Krugman said, with prices down over 200-basis-points from their high in 2022.
That will play into how the economy reacts when the US finally starts paying off its debt. Decreasing the deficit will hinder economic activity, but that can be remedied by lowering interest rates.
As a result, Krugman predicted the US would head back into a low interest rate environment over the next few years. And once we hit near-zero interest rates, paying off the debt could lead to trouble, since rates can’t be lowered any further.
“If we find ourselves back in a low-interest rate world, that will also be a world in which trying to reduce the debt would cause a lot of economic problems at a time when the Fed lacked its best tool for dealing with them,” he warned.
Nouriel Roubini previously said that the Fed would be powerless to a looming debt crisis, since officials can’t afford to lower interest rates with prices still well-above the 2% inflation target. That could mean the US sees high inflation and a debt problem simultaneously, he said, warning of a severe financial crash to hit the economy.