Yesterday I testified at the Committee on the Budget of the House of Representative. John Yarmuth chaired, and Steve Womack was the ranking member. The Committee titled the hearing “Reexamining the Economic Costs of Debt,” which was quite different from the title “Why Congress Must Balance the Budget” of a hearing of the same House Committee at which I testified only a few years ago in 2015.

At the earlier hearing I showed that basic economic theory grounded in real world data implies that high federal government debt has a cost: it reduces real GDP and real income per household compared to lower debt levels. At yesterday’s hearing I reported that a reexamination of the economic costs yields the same results. A fiscal consolidation plan which reduced debt to GDP would lead to an immediate and permanent increase in real GDP according to model calculations.

Recently the Congressional Budget Office (CBO) reported similar results. They compared their “extended baseline” in which the debt goes up to 144 percent of GDP by 2047 with an “extended alternative fiscal scenario” in which the federal debt goes to 219 percent of GDP. CBO found that real GNP is 3.6 percent lower when debt is higher. So, the higher level of debt has real economic costs.

The CBO also analyzed scenarios in which debt is lower as share of GDP: 42 percent and 78 percent. In the 42 percent scenario, real GNP would be 5.8 percent higher; in the 78 percent scenario, real GNP would be 3.7 percent higher.

With the CBO currently projecting large increases in the federal debt relative to GDP in the United States, this reexamination implies the need for a credible fiscal consolidation strategy. Under such a strategy spending would still grow, but at a slower rate than GDP, thereby reducing debt as a share of GDP compared with current projections. Such a fiscal strategy would greatly benefit the American economy. It would also reduce the risk of the debt spiraling up much faster than projected by the CBO.

This conclusion is robust. Olivier Blanchard also testified at the hearing emphasizing that if the growth rate of the economy is greater than the relevant interest rate on the public debt, then there will be a tendency for the debt to GDP ratio to decline over time. In most of Blanchard’s simulations, the primary surplus is held to zero. However, the primary deficit is far from zero, and, according to CBO, it is growing. Moreover, the economic costs do not distinguish between the primary and the total deficit.

Another view of the economic costs of debt is related to what is sometimes called “Modern Monetary Theory.” It is difficult to determine how this approach would work in the future, and it is frequently associated large spending programs and wage and price controls. Model simulations would be useful, but history can be a valuable guide:

In the 1970s the United States imposed wage and price controls and the Fed helped finance the federal deficit by creating money. The result was a terrible economy with unemployment and inflation both rising. This ended when money growth was reduced in the late 1970s and early 1980s. As explained in a forthcoming book by George Shultz and me, it is an example where poor economic reasoning led to poor economic policy and poor economic performance. It was reversed when good economics again prevailed, and policy changed.