Are We in a Fiscal Doom Loop?

When a former Treasury Secretary looks at the U.S. government’s current fiscal policy, what do you suppose keeps them up at night?

If you’re Larry Summers, who served as former President Bill Clinton’s Secretary of the Treasury, that something is called a “doom loop”. Fortune summarizes Summers’ recent comments on that topic when he appeared on Bloomberg Television’s Wall Street Week.

Governments need to pay increasing attention to their budgets, with mounting deficits alongside surging borrowing costs having the potential for shaking confidence, he said. In the US, student-loan forgiveness, emergency funding for Hurricane Ian and rising defense spending needs suggest that fiscal debates will need to be “back on the table,” he said.

“If your deficit projection starts to get out of control and your real interest rates start to rise rapidly, you can get into a kind of doom loop,” said Summers, a Harvard University professor and paid contributor to Bloomberg Television. “We’re going to need to be watching our own fiscal projections in the United States very carefully.”

Summers is one of the few economists to correctly predict the excessive spending from President Biden’s American Rescue Plan Act would unleash an era of high inflation. When he says the U.S. government could find itself in a doom loop because of its continued excessive spending, it draws attention.

What Is a Doom Loop?

Here’s how Investopedia answers that question:

A doom loop describes a situation in which one negative action or factor triggers another, which in turn triggers another negative action or causes the first negative factor to worsen, continuing the cycle. It is equivalent to a vicious cycle in which a downward trend becomes self-reinforcing. The term was popularized in the 2001 management book Good to Great by Jim Collins.

In economics, a doom loop describes a situation in which one negative economic condition creates a second negative condition, which in turn creates a third negative condition or reinforces the first, resulting in a self-reinforcing downward spiral.

In the current environment, the doom loop would start with President Biden’s excessive spending funded by borrowing that increases the national debt. To combat that inflation, the Federal Reserve will hike interest rates. As it hikes interest rates, the U.S. government has to pay its creditors more to borrow.

That increased cost then does one of two things. It reduces the amount of money available for the government to spend on things politicians want. Or it increases the amount of borrowing politicians will do to keep their spending going.

The doom loop phenomenon sets in when politicians choose the path of borrowing more to keep spending more. That choice reignites the cycle of increased spending that drives up the national debt. It can quickly get much worse when debt taken out to pay for old spending comes due for payment. Too much spending means it has to be rolled over into new debt at higher interest rates. In the very worst case, the doom loop becomes a death spiral.

In 2019, before the pandemic, the U.S. Treasury Department’s Office of Debt management said the U.S. government was just five years away from a national debt death spiral. With President Biden’s fiscal policies, that timetable has moved earlier on the calendar.