National Debt Economic Impact Classical Keynesian Theory

Three schools of thought on the economic effects of national debt are the Classical school, the Keynes school, and the school of Modern Monetary Theory (MMT). The Classical view is that high national debt can undermine long-term economic growth. The Keynes school views national debt more as a tool for growth and stability rather than as a problem for growth. MMT school argues that high national debt is basically a boogeyman, for governments can always just inflate the debt away by creating more money supply. This of course has its own problems, as loss of confidence in a currency can erode its value as an asset (Barrows, 2022).

The Classical theory is based on the notion of equivalence, put forward by David Ricardo: when the government finances deficits by borrowing, the consumer can reasonably expect that the debt will eventually have to be paid back. This happens by way of taxation. In effect, the government borrows from future generations or pulls forward the expected wealth of tomorrow for uses today. That is why classical economists argue that excessive government borrowing can lead to stagnation, as interest rates have to rise to attract buyers of debt and private investment bows out of investing in the economy because interest rates are too high (Barrows, 2022).

Keynesian economists argue that national debt is a useful and necessary tool for bringing stability to the economy. It is most helpful during recessions: governments intervene by spending to create demand. This keeps businesses in business, workers employed, and the economy growing. The idea is that governments should borrow when there are downturns and reduce their debt when the economy is able to grow on its own once again. The problem is that too much intervention for too long creates distortions, zombie companies, and artificial economies that are centrally controlled. For a high national debt to not be a problem, the borrowed funds must be used to stimulate economic activity and the economy must grow at a rate that outpaces the debt burden. Considering the amount of government waste that is seen in real life, the Keynes view is somewhat myopic (Arestis, 2011).

MMT is basically Keynes theory with its eyes closed and its head willfully buried in the sand; i.e., if you ignore it, it is not a problem. MMT suggests that nations that issue their own currency cannot \\\\\\\"run out of money\\\\\\\" or face a debt crisis because governments can finance spending by creating more currency, and the primary constraint is inflation rather than debt levels. Thus, the problem theoretically is runaway inflation—not debt. MMT theorists do not bother to see how debt and inflation are connected, and how too much of one can lead to too much of the other—i.e., hyperinflation Weimar style (Barrows, 2022).

The long-run costs of high national debt are apparent in the interest that must be paid. The more debt accrued, the more must be budgeted to service the debt. The more money that must go to servicing the debt, the less money there is for social programs like Medicaid or infrastructure. Also, the more the government borrows, the more pressure is put on loans, which can cause private investment to go where credit is easier and cheaper to access.

Another long-run cost is inflation, and one can see this in the US since the Great Recession and the lockdowns of 2020. Stimulus upon stimulus was given, and the net effect has been soaring prices across all asset classes. Meanwhile, wages have not kept pace. The value of money has gone down for people due to all the money-printing that transpires when national debt grows and grows.

At the same time, the risk of inflexibility increases. As the debt load rises to unprecedented levels, a nation soon finds it does not have room to address future financial crises. It begins to feel like one’s credit card has maxed out. MMT proponents would say this is not possible—but anyone living in reality who deals with inflation on a day-to-day basis knows very well that inflation will max out one’s credit quickly. A nation’s credit is really no different. The ability to finance debt is not as infinite as MMT proponents think. Sooner or later, credit ratings drop and creditors can look elsewhere for return. The US for instance is not immune to any of this. It enjoys some room now because it prints the world’s reserve currency. But if debt load continues to go up, the world could abandon the USD.

The costs of eliminating the budget deficit are that the government usually needs to raise taxes or cut spending (White & Wildavsky, 2021). Or it can issue tariffs as President Trump has argued. If it chooses taxes, no one likes that. Voters remember it. It reduces disposable income. It can cause political backlash. If it chooses spending cuts, it means cutting down on social programs. Again, this is not a win for many citizens. It can cut spending, as on defense and education or infrastructure—or it can go after government waste the way the Department of Government Efficiency is now doing in exposing USAID. Cutting spending, raising taxes—these are not popular—but eliminating waste can be a huge gain.