How much debt can America handle? The question is one of the most fundamental the nation faces, and the answer should determine how the United States handles the delicate task of reducing budget deficits without walloping economic growth.
A new paper argues that the number that should make people nervous is 80. That is, that the ratio of 80 percent public debt to gross domestic product is the point at which a nation becomes vulnerable to tipping points on debt. The idea is that once a nation has debt above that level, it becomes vulnerable to the kind of self-reinforcing vicious cycles that have put nations into a bad position in the past. High debt levels lead investors to view the country's bonds as less desirable, so they demand higher interest rates.
Higher interest rates make the country's debt burden more onerous, and so investors sell off bonds all the more. When that cycle takes hold in a truly vicious way, the only endings are high inflation or a default.