Bernstein Warns U.S. Debt Crisis Looms as Interest Rates Surpass Growth

Jared Bernstein, a former chair of President Joe Biden’s Council of Economic Advisers, has shifted his stance on U.S. debt, transitioning from a dove to a hawk due to the increasing danger posed by the nation's budget math. He attributes this change to the economic policies of President Donald Trump, particularly his tariffs and tax cuts.

The U.S. is on a trajectory that could lead to a debt shock, reminiscent of the unsustainable student loan crisis, according to Bernstein. He acknowledges his past advocacy for fiscal austerity, but now believes the situation has become too dire to ignore. The key issue, he explains, is the relationship between economic growth and debt interest. Governments can sustain budget deficits if GDP growth outpaces the interest rate on their debt. However, if debt interest grows faster than income, as seen in the student loan crisis, the situation can quickly become unsustainable.

Bernstein draws a parallel between the student loan crisis and the U.S. debt outlook. Just as college graduates can manage their loan payments if their income rises faster than their loan bills, the U.S. government can sustain its debt if economic growth outpaces interest rates. However, if debt interest grows faster than income, the situation can become dire, as seen in the student loan crisis with soaring delinquency rates and plummeting credit scores.

Bernstein points out that the federal government's debt costs relative to income have become more concerning. Since the early 2000s, the inflation-adjusted yield on 10-year Treasuries was below the running 10-year forecast for economic growth. However, this has changed recently, with the two now converging at just above 2%. This shift is due to government spending during the pandemic and higher inflation, which forced the Federal Reserve to hike interest rates aggressively, dragging yields higher.

Bernstein suggests that Congress pre-determine "break-glass moments" and binding fiscal responses to avoid a debt shock that could force the government to slash spending or raise taxes. He also notes that the U.S. already pays more in interest on its debt than it spends on Medicare and defense, with those interest payments expected to hit $1 trillion next year. This is a significant concern, as it trails only Social Security as the government’s biggest outlay.

Bernstein's warning comes as Trump's tax cuts and spending are expected to add trillions to the deficit in the coming years, with the total surpassing the post-World War II record soon. This path remains unsustainable, with the primary deficit much larger than usual in a strong economy, the debt-to-GDP ratio approaching the postwar high, and much higher real interest rates putting the debt and interest expense as a share of GDP on much steeper trajectories than appeared likely last cycle.