US Debt Dynamics: A Study's Warning for Today

A new study by Julien Acalin and Laurence Ball revisits the post-World War II debt dynamics in the United States. The researchers examined how America shed its wartime debt, which had surpassed 100 percent of GDP after the war.

Their analysis found that economic growth alone was not responsible for the decline in debt; instead, a combination of factors contributed to it. These included government primary surpluses and distortions in interest rates caused by the Federal Reserve's wartime interest rate peg and surprise inflation.

The authors constructed counterfactual scenarios to assess the impact of these distortions on the debt-to-GDP ratio. They found that interest-rate distortions had a massive effect, accounting for about 40 percentage points of the decline in the debt-to-GDP ratio from 1946 to 1974.

The researchers warned that these historical contingencies are unlikely to recur, making it difficult for the US to rely on economic growth to reduce its current debt burden. The Congressional Budget Office projects persistent primary deficits, and with interest rates and growth rates roughly balanced in recent years, the mechanisms that reduced debt over the 20th century no longer seem applicable.