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Contact: Katharine Keenan (202) 454-1334 March 25, 2011

Debt Outlook Threatens US Economy

Two important new studies to be published by the Peterson Institute for International Economics warn that mounting
public debt in the United States and other advanced countries pose a major threat to global economic stability if corrective
action is not initiated in the near future. The new research projects that the government debt of the advanced countries
would rise to almost 200 percent of their combined GDP by 2035 (from about 70 percent today) in the absence of
corrective action. Such a trajectory would be far outside historical experience and could well trigger major financial crises
for the United States and other countries.

If debts and deficits are not curbed, sluggish economic growth is likely: The historical record shows that growth rates
decline by a full percentage point annually once debt/GDP ratios exceed 90 percent. The potential outcomes include
much higher interest rates, the crowding out of productive private investment, and “financial repression” imposed by
governments on banks and other institutions. In the case of some countries, there could be debt restructurings or defaults.

The new analyses are The Global Outlook for Government Debt over the Next 25 Years: Implications for the Economy and
Public Policy, by Joseph E. Gagnon with Marc Hinterschweiger, and A Decade of Debt, by Carmen M. Reinhart and
Kenneth S. Rogoff. Gagnon, a former associate director of the division of monetary affairs at the Federal Reserve Board,
is a senior fellow at PIIE. Reinhart is the new Dennis Weatherstone Senior Fellow at PIIE, and Rogoff is a professor of
economics at Harvard University. Reinhart and Rogoff are coauthors of This Time Is Different: Eight Centuries of Financial
Folly, published in 2009 to widespread acclaim from reviewers and scholars. The two new studies are to be published
in June, but PIIE is making their contents public today in light of the urgency of the issues, as highlighted by events in
Europe and Japan as well as the growing debate in the United States. Both were undertaken with financial support from
the Peter G. Peterson Foundation, a New York–based organization dedicated to increasing public awareness of the nature
and urgency of key long-term fiscal challenges threatening America’s future and to accelerating action on them.

Gagnon and Hinterschweiger project the public debt of all major countries to 2035. They show that, on current trajec-
tories, the aggregate level of such debt in the advanced countries would rise to perhaps 200 percent of the GDP of the
group from less than 70 percent today. These numbers are far removed from any historical experience and are clearly
unsustainable. By contrast, public debt in the emerging market economies is likely to rise from current levels of about
30 percent to only 40–60 percent. The projections are shown in the attached table.

1750 Massachusetts Avenue, NW Washington, DC 20036-1903 Tel 202.328.9000 Fax 202.659.3225 www.piie.com
The advanced countries should thus start planning now to take corrective steps after their recovery from the recent
downturn is well established. Planning should begin now, the authors say, because delay will make adjustment more
difficult, and markets are waiting for a signal that governments are serious about the problem. “Although we have time to
act, time is not on our side,” Gagnon and Hinterschweiger say. Their study includes a series of charts offering net debt,
interest rate, and interest payment projections under various scenarios for the United States, Japan, and the euro area
through 2035. These show that such payments are not sustainable by any measure for the United States and Japan or by
some measures for the euro area. They also suggest that reaching even partial agreement soon on long term changes to
retirement and healthcare costs “could send a signal to markets that advanced governments are prepared to deal with a
problem that threatens to grow more serious in the next two or three decades.”

In A Decade of Debt, Reinhart and Rogoff survey the historical record and present evidence that, in part because of the
global financial crisis, public debt in advanced economies has surged in recent years to levels not recorded since World
War II and surpass debt levels reached during World War I and the Great Depression. They also call attention to private
debt levels by financial institutions and households. “Historically, high leverage episodes have been associated with slower
economic growth and a higher incidence of default or, more generally, restructuring of public and private debts,” they
write. Once debt levels exceed a threshold of 90 percent of GDP, growth tends to slow by about 1 percent annually from
previous levels.

The authors further suggest that these high debt levels could return the world to debt restructurings and “financial
repression.” Such repression could take the form of government-imposed interest rate ceilings, curbs on banks paying
interest rates above a certain amount, and multiple regulations that force private financial institutions to lend to govern-
ments. Reinhart and Rogoff warn that, based on the record of financial crises in the past, the years from 2008 to 2017 “will
be aptly described as a decade of debt” with ominous portents for the future. Historically, such levels of debt are associated
with slower economic growth and higher incidences of sovereign default, banking crises, or restructuring of public and
private debts. Their study also examines the dangers of contagion if one country’s problems spill over to other countries.

About the Peterson Institute for International Economics

The Peter G. Peterson Institute for International Economics is a private, nonprofit, nonpartisan research institution
devoted to the study of international economic policy. Since 1981 the Institute has provided timely and objective analysis
of, and concrete solutions to, a wide range of international economic problems. It is one of the very few economics think
tanks that are widely regarded as “nonpartisan” by the press and “neutral” by the US Congress, its research staff is cited by
the quality media more than that of any other such institution, and it was selected as Top Think Tank in the World for
2008 in the first comprehensive survey of over 5,000 such institutions. Support is provided by a wide range of charitable
foundations, private corporations and individual donors, and from earnings on the Institute’s publications and capital
fund. It moved into its award-winning new building in 2001, and celebrated its 25th anniversary in 2006 and adopted
its new name at that time, having previously been the Institute for International Economics.

2
Table 2 General government net debt projections (percent of GDP)
2005 2010 2015 2020 2035
United States
Optimistic growth 43 65 86 97 155
Baseline 43 65 86 99 213
Pessimistic growth 43 65 86 99 302
Pessimistic health cost 43 65 86 103 331
High interest rates 43 65 86 100 270
CBO-A (federal only) 37 62 73 87 185
Euro area
Optimistic growth 55 67 73 74 72
Baseline 55 67 73 76 133
Pessimistic growth 55 67 73 76 155
Pessimistic health cost 55 67 73 80 224
High interest rates 55 67 73 76 144
Japan
Optimistic growth 85 121 153 181 335
Baseline 85 121 153 183 386
Pessimistic growth 85 121 153 183 504
Pessimistic health cost 85 121 153 185 435
High interest rates 85 121 153 185 482
Advanced economies
Optimistic growth 48 67 81 88 122
Baseline 48 67 81 90 178
Pessimistic growth 48 67 81 90 234
Pessimistic health cost 48 67 81 94 276
High interest rates 48 67 81 91 210
Emerging economies
Optimistic growth 34 27 26 23 35
Baseline 34 27 26 24 40
Pessimistic growth 34 27 26 25 59
Pessimistic health cost 34 27 26 24 54
High interest rates 34 27 26 24 40
World
Optimistic growth 45 54 59 60 74
Baseline 45 54 59 61 98
Pessimistic growth 45 54 59 62 130
Pessimistic health cost 45 54 59 64 144
High interest rates 45 54 59 61 110
Source: Author calculations and IMF fiscal data and projections for 2005–14.
GRAPHICS 45