Debt Crisis in the United States - "US Economy Faces Weaker Growth"

Questions & Answers

The United States has raised its legal debt limit by $2.1 trillion. Additionally, the country plans to save $2.4 trillion over the next ten years. Dr. Marcus Kappler, deputy head of the Growth and Business Cycles research group at ZEW, calls for a turn in US fiscal policy.

Having studied economics at the University of Tuebingen, the University of Maryland, USA, and the Free University of Berlin, Marcus Kappler received his Ph. D. ("Dr. rer. pol.") from the University of Frankfurt in 2007. Since January 2002, he has been working at ZEW and currently holds the position of deputy head of the Growth and Business Cycles research group. His research focuses on the accuracy of economic forecasts, structural unemployment and influencing factors on production capacity.

The insolvency of the United States was averted at the last minute. Can markets trust the US economy again?

The US Senate has finally decided to raise the debt ceiling defined by the budget laws. This agreement allows the United States to borrow more money and also includes budget consolidation measures. However, many observers consider the plans to cut the deficit as insufficient. Therefore, the rating agency Standard & Poor’s downgraded the United States' top-notch AAA credit rating and announced that it might again lower the US rating within the next years, unless deficit reduction plans were improved. One of the reasons for the downgrade is the tactically motivated debt row in Congress, which has weakened the predictability of American policymaking. The immediate reaction of the markets showed that uncertainty about the future of the world economy has increased due to the downgrading of the credit rating.

The United States has accumulated a debt of over $14 trillion. Does this huge amount of debt threaten the development of the US economy?

The national debt has risen that dramatically because mitigating the financial crisis cost the US government a great deal of money. The largest proportion of the American Recovery and Reinvestment Act (ARRA), an economic stimulus package signed into law in 2009, is made up by tax cuts for individuals and married couples in order to increase their disposable income and thus raise consumer spending. ARRA still has a short-term positive effect on the US economy. In the long-term, however, the high indebtedness of the United States is a problem and will surely strain economic growth. The Congressional Budget Office (CBO) has calculated that from 2017, the negative impacts of the high national debt will exceed the growth stimulating effects. This is, for example, due to lower income tax rates. In the medium- to long-term future, the US will face weaker economic growth, unless a change of direction is taken.

What are the consequences of the US budget deficit for the world economy and especially for the euro area?

If the Senate had not agreed on a compromise deal, the US would have faced a partial default on its debts, which would probably have had a devastating effect on the world economy and thus also on the euro area. US government securities are traded on a large scale by investors all over the world. A default presumably would have caused a new confidence crisis in the global banking sector. And since the collapse of Lehman Brothers, many are afraid of the effects of a new financial crisis on the real economy. Along with the debt limit increase, the United States announced a long-term austerityprogramme, which is necessary to permanently reduce debt and thus return to a sustainable debt level. This is a first step towards fiscal consolidation. The United States has reached a point where a turn in fiscal policy is inevitable.

Some euro area countries are highly indebted as well. To what extend can the situation in Greece, Portugal, Italy and Spain be compared to the United States?

The United States at least used to be more adaptable to economic shocks and the society used to be better able to adapt to changing circumstances than in many other economies. The situation can hardly be compared to countries such as Greece. Greece is de facto insolvent and is only being kept afloat by the European rescue fund. The credit worthiness of Greek government bonds was lowered to a high probability of default and Portuguese bonds are regarded as very speculative by rating agencies. In contrast, the credit rating of US bonds was only lowered from “highest quality” to “safe” and it was only one of the big rating agencies that downgraded the US rating. The current deterioration of the situation in Italy and Spain is alarming. The risk premiums for government bonds have soared in these countries. Compared to the smaller countries on the periphery of the euro area, the problem of Spain and Italy consists in their size. The European rescue fund would not be able to shoulder the burden of another de facto insolvency as seen in Greece.