by EVSEY D. DOMAR
Division of Research and Statistics, Board of Governors
On November 30, 1945 the Federal debt reached 265 billion dollars, a magnitude without precedent in the history of this country. With the present interest rate structure, it involves an annual service charge of more than 5 billion dollars, an amount exceeded by only two peacetime Federal budgets until 1934.1 It is quite understandable that a debt of this magnitude should cause considerable apprehension, and that a policy of repaying at least a part of it should be advocated so often.
It is true that our economy would be better off without so large a debt. But this does not mean that our position can be always improved by reducing the debt. The difficulty lies in the fact that the various components of our economy are interdependent, so that it is impossible to change one without affecting the others. In particular, the debt problem is more complex and difficult than it appears on the surface because changes in the debt exercise a powerful effect on the size of the national income.
Effects of Debt Changes on Income. In general, when the debt increases, that is, when the Government borrows and spends, national income is above the level where it otherwise would be; when the debt is reduced, that is when tax yields exceed expenditures, the income level is depressed. This rule does not necessarily hold. Should the Government borrow funds which would be spent on goods and services anyhow, and use them for expenditures which do not create income, such as a purchase of land, national income would fall rather than rise. Similarly, a repayment of the debt does not always depress national income; if taxes come from idle funds which would not be used anyhow, while the bondholders whose bonds are redeemed use the proceeds for consumption or investment, national income will indeed rise. But with all these qualifications____________________