How Much Debt is Enough? The Link Between Infrastructure Investment and Public Debt
Due in large part to the Great Recession of 2007-09 and the subsequent policy response by the federal government, total U.S. public debt increased rapidly from just over $8.8 trillion in the first quarter of 2007 to nearly $20 trillion by the first quarter of 2017. Gross Domestic Product (GDP) grew at a much slower pace during this period, and as such, the U.S. public debt increased from 62 percent of GDP to 104 percent of GDP.
Economists and policymakers often view a country’s public debt as a percent of its GDP as an important indicator of economic and fiscal health, with larger values representing more negative outcomes. Therefore, the rapid increase in public debt relative to GDP experienced in the U.S. during the past decade has been a cause for concern for many elected officials and the public.
While conventional wisdom may suggest that increases in public debt as a percent of GDP are problematic, it is important to consider how a government spends the debt it is accruing.
To study the impact of public debt accumulation on economic outcomes, we developed a macroeconomic model of the U.S. economy that replicates important aggregate and disaggregate measures, such as the degree of income inequality and the concentration of wealth. Simulating the model under a variety of policies allows us to determine which debt policies yield the best outcomes, the highest gains to consumers, producers and the government.
Our research considers the connection between infrastructure investment and public debt when evaluating various debt policies. Public infrastructure is the roads, highways, ports, airports and water systems typically provided by the government.
Additional infrastructure investment provides spillovers to the economy in the form of higher productivity, which results in higher wages and higher returns to savings. For example, firms benefit when the government builds a new highway that helps connect their factories to the marketplace.
These firms are more productive, sell more products and pay their workers higher wages. If public debt is used to finance additional infrastructure, then the optimal level of public debt may be different than when public debt is issued to fund less productive things.
Our research found it is optimal for the country to run a public debt. Increasing public debt to help fund government expenditures avoids a potential tax increase that would be required to fund those government expenditures. Such a tax increase would negatively affect households by reducing their after-tax wages and return on savings. Therefore, running a public debt may be optimal in this situation.
More public infrastructure increases the productivity of firms and thus raises wages and rates of return on savings, yielding an increase in GDP. The increase in GDP causes tax revenue to rise without needing to raise tax rates or issuing larger debts.
So we found that the optimal level of debt is smaller when infrastructure is considered. Specifically, its value is about 100 percent of GDP. Coincidentally, this is about the level of U.S. debt now.
In conclusion, accumulating some amount of public debt is found to be optimal because it allows governments to provide additional goods without the need to increase taxes in the short run. However, if this debt is used to fund productive public investments, such as infrastructure projects, then the optimal level of debt is near 100 percent of GDP for the U.S. economy. Further increases past this level may lead to adverse outcomes, such as lower consumption and GDP.