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Thursday, November 03, 2005

Who Receives the Interest Paid on the Debt?

This is in response to a question. Interest expense as a percent of GDP is shown in this graph from the Congressional Budget Office:

Federal Outlays, 1962 to 2001 as a Percent of GDP

Is the interest of the debt a burden? Fifteen years ago, I would argue that only 10-15% of the debt was held by the foreign sector, so only 15% of the interest represented a burden. Why? If you tax everyone to pay the debt, money is collected in the form of taxes, then paid out to bondholders. In aggregate, this redistributes income, but there is no change in the amount of income due to the income transfer (I find it interesting that these types of income redistributions do not receive the kind of press that other types do). Only the 10-15% that flows out of the US wass a loss, but we held foreign debt too and when this is netted out the net interest flow was fairly small. That has changed. At the end of 2004, 44% of the federal debt was held by the foreign sector (see page 258), so it's much harder to argue that the debt does not represent a drain of resources to the foreign sector.

What is the net outflow? Here's one set of estimates from a Chicago Fed Letter based upon all assets, i.e. this is our net foreign debt position

We went from a position of net inflow prior to 1985, to a net outflow of 4.4% of GDP in 1994, to a 23% net outflow in 2004. 23% of GDP is more than a few pennies. The graph also shows why the net change has been so large in recent years. Foreign ownership has not accelerated. Instead, US purchase of foreign assets as a percent of GDP has fallen since approximately 1999.

    Posted by on Thursday, November 3, 2005 at 12:06 AM in Budget Deficit, Economics, International Finance | Permalink  TrackBack (0)  Comments (1)

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