To be clear, the debt in question is debt held by the public, the money that the government borrowed from banks, investors and foreign governments to finance past deficits. Debt held by the public was $12.5 trillion or about 73 percent of gross domestic product at the end of April.

[SEE: Cartoons on the Budget and Deficit]

That’s significantly lower than the “gross debt,” now about $17.5 trillion, found on the “debt clocks” that are so popular with debt hysterics. Gross debt (and its close cousin, “debt subject to limit”) is debt held by the public plus debt internal to the government — Treasury securities that the government itself holds in Social Security and other trust funds. The latter does not affect the economy or the government’s creditworthiness; debt held by the public is the far better measure for assessing how debt affects the economy.

Furthermore, deficit and debt burdens can be properly assessed only in relation to the size and condition of the economy. Between 1946 and 1974, for example, the government ran deficits almost every year and debt held by the public grew significantly in dollar terms, but the economy grew substantially faster. As the chart shows, debt shrank dramatically as a percentage of GDP, from 109 percent to 24 percent.

The condition of the economy matters as well. Large deficits and rising debt in a healthy economy are a recipe for weaker future growth. When the private demand for investment is strong, government borrowing can “crowd out” productive private investments important for strong future growth.

[GALLERY: Cartoons on the Economy]

Temporary increases in deficits and debt in an economic slump, however, can cushion the downturn and hasten the recovery. When private investment demand is weak, deficit-financed spending and well-targeted tax cuts have a high “bang-for-the-buck” impact in stimulating the demand needed to restore full employment.

A rising debt ratio in good times reflects an unsustainable budget policy that ultimately poses threats to financial stability and long-term growth. Thus a stable — or declining — debt-to-GDP ratio is an appropriate goal for fiscal stability, with allowances for temporary increases during hard times or major emergencies. The Center on Budget and Policy Priorities’ projections show that policymakers must do more to reach that longer-term goal. At the same time, however, the economy remains sluggish and well short of full employment. Under these circumstances, too much deficit reduction, too soon, would slow the recovery.

In crafting policies to encourage a stronger economic recovery without neglecting longer-term deficits and debt, policymakers should not fixate on any particular target level of debt. The once-popular notion that the economy will fall into a slow-growth morass if the debt ratio tops 90 percent of GDP has been thoroughly debunked.

[READ: The Budget Picture Is Getting Better. Seriously.]

All else being equal, policymakers should prefer a lower debt-to-GDP ratio because policymakers would have more flexibility to address economic or financial crises and the government’s interest burden would be lower. But all else is never equal.

Lowering the debt ratio comes at a cost, not only risking the recovery if it’s done too fast but also in burdening businesses and households with larger spending cuts, higher taxes or both to stabilize the debt ratio. Still, there’s lots of room for smart policy between the path we’re on to higher debt burdens down the road and the House budget with its immediate slash-and-burn budget cuts.



