Although long-term government interest rates are now very low, they are beginning to rise in response to the outlook for a sharply rising national debt. The national debt held by US and foreign investors totaled about 40 percent of GDP at the end of last year. It is likely to rise to more than 60 percent of GDP by the end of next year, with the debt-to-GDP ratio continuing to increase. The resulting increase in real long-term interest rates will reduce all forms of interest-sensitive spending, adding further to the economy’s weakness.
So it is not clear what will occur to reverse the decline in GDP and end the economic downturn. Will a sharp US dollar depreciation cause exports to rise and imports to fall? Will a rapid rise in the inflation rate reduce the real value of government, household and commercial debt, leading to lower saving and more spending? Or will something else come along to turn the economy around.
Only time will tell.
Martin Feldstein, professor of economics at Harvard, was a former chairman of former president Ronald Reagan’s Council of Economic Advisors and a former president of the National Bureau for Economic Research.
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