Why is government debt bad?

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    I had a buddy who was talking to someone who asked him why debt was bad. The government can just get into debt perpetually. My buddy couldn’t really explain fully and asked me and I wasn’t too happy with my articulation.

    Basically, I said the government has to service the debt. The greater the debt, the greater the interest payment. If the government accrues more debt, the interest payment gets larger, which takes up a greater portion of the budget which takes away from other items that must be paid for which leads to borrowing more to finance the increased deficit which leads to greater debt and thus even larger interest payment. If the government refuses to pay the debt or investors see the government at risk of not paying for the debt, interest rates would increase thus making the cost of servicing the debt even greater until it essentially takes up the entire budget and breaks down the government.

    Do you have a better way of articulating to the layman why exactly debt is bad?



    If the government accumulates debt, it has to borrow money. The resources that are used to finance government spending are dragged from the private productive sector into the public sector. These resources cannot be used to finance private investment which is a lot better for the economy than government spending. Moreover, if the government borrows a lot of money, there’s less money available to be loaned out to private individuals and companies which leads to higher interest rates which makes private investment less profitable.

    If the government monetizes the debt, the debt is payed by new money created by the Central Bank (in the US the FED). In that case, the money supply increases, the value of the currency falls, prices rise etc. The interest rates might be forced down and trigger an unsustainable boom.

    The government might default on it but then spending has to be cut dramatically because nobody will lend money to the government in the future. So entitlements would have to be cut and austerity measures implemented.
    If it is payed back, then the government will have to collect more taxes in the future which sucks more resources out of the private sector.


    There is also the issue of crowding out. Government spending can only come from one of three sources: taxation, debt, and money printing. Taxation is economically inefficient, and diverts resources away from their most productive use to less productive, politically favored uses. Debt does much of the same, with the added penalty of interest, as discussed above. Money printing will also do this by creating inflation.

    In other words, if the government “borrows” a million dollars from an actual person, business, or foreign government, that million dollars is immediately gone, and transferred to an entity (the US federal government) that is likely to spend it on less urgent needs than what it would have otherwise been spent on. That alone is a problem with government debt, regardless of whether it is ever actually paid back or not.

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