Debt and Economic Activity in the United States

This paper documents a long-standing stability in the relationship between outstanding debt and economic activity in the United States, and explores the implications for capital formation of several hypotheses that could explain this observed phenomenon. The aggregate of outstanding credit liabilities of all nonfinancial borrowers in the United States bears as close a relationship to U.S. non- financial economic activity as do the more familiar asset aggregates like the money stock (however measured) or the monetary base. This stability in the debt-to-income relationship reflects the net outcome of pronounced but offsetting movements of the public and private components of the total debt aggregate. Three different hypotheses provide potential explanations for this phenomenon. Two of these, one emphasizing taxpayers' actions and one based on credit market borrowing constraints, carry the implication that increases in government debt outstanding associated with financing budget deficits crowd out private financing and hence private capital formation. The third hypothesis, which emphasizes the portfolio preferences of lenders, implies that increased government financing will not crowd out private capital formation but will cause the private sector to shift from debt to equity financing.