The impact of the Federal Government debt on macroeconomic stability in the United States

Abstract

This study determines the public debt-to-GDP levels for the United States to identify debt thresholds that support macroeconomic stability, with a focus on price stability and low unemployment. Unlike previous studies that analyze how debt impacts economic growth, this research looks at how inflation and unemployment react to the rising debt ratio at different levels of debt. The analysis starts by estimating the relationship between changes in public debt and changes in real GDP, noting a significant shift in 2008Q1 coinciding with the onset of the global financial crisis. Prior to the crisis, debt increases had no impact on GDP, but afterwards, an inverse relationship emerged. The analysis then proceeds with the sequence of two tests. Firstly, by conducting SETAR(2,p) testing on quarterly data from 1996 to 2024, two debt ratio thresholds are identified at 55.75 % and 97.12 %. This categorizes the debt ratio in three zones: a low debt zone below the lower threshold, a high zone above the upper threshold, and an intermediate zone in between. The tests examine the debt ratio in relation to changes in the core PCE annualized inflation, the rate of unemployment and the federal funds effective rate as a non-switching regressor. Subsequently, cointegration and VECM(2,5) tests are conducted to examine interactions and determine impulse responses between the debt ratio, inflation and unemployment in each debt zone. Findings indicate that increases in the debt ratio do not impact inflation or unemployment in the low debt zone. In the intermediate zone, rising debt leads to an increase in unemployment. Conversely, in the high debt zone, both inflation and unemployment increase significantly with rising debt. These non-linear and reverse causal relationships suggest that the current high public debt in the US is detrimental to macroeconomic stability, highlighting the need for urgent policies to reduce the debt burden.