The deficits and national debt have increased exponentially over the past 10 years because of costly wars fought with expensive contractors, large expansions of federal authority, escalating health care costs weighing down on Medicare/Medicaid, and bailouts to well connected financial houses, along with several unfunded liabilities that push costs forward not included in the cost of the deficit. GDP growth has been slow for the past couple of years because of excessive deleveraging of private sector debt, along with large corporations and banks hoarding cash, rather than reinvesting it back into the economy. Many are not confident that the worst has passed.
When talking about the deficit, usually it is mainly a problem when long-term interest rates are high, and not much so when they are low. The Federal Reserve dictates short-term interest rates, but long-term rates are still pretty much set by the market in a sometimes ruthless manner. When long-term interest rates are high (like they were in the late 1970's and the 1980's), it competes against and "crowds out" private borrowing and investment, thus slowing down the economy. As opposed, when long term interest rates are low like they are today, the federal deficit shouldn't take away from private sector borrowings. On the contrary, the deficit would act as a needed boost to aggregate demand. This is how fiscal policy works under normal circumstances, which we're not in at the moment. When the economy is slack, every dollar of reduction in federal spending takes away double or triple that amount in GNP.
Interest rates today are at the lowest they have ever been. It is being kept down by way of debt monetization through aggressive Treasury buy-back programs of securities and other investments owned by the FED. Because the dollar is the world's reserve currency, we have a deep liquidity base that can be tapped to support these programs. Any inflationary effects are exported to other countries. So what can we infer from that about the deficit? Theoretically, it should not be as problematic as in recent history, but with unfunded liabilities up to 10 times the cost of the total base deficit, it is creating a whole new set of problems for our fiscal outlook. The problem is basically one of malinvestment and corruption. This is something that neither party would care to discuss.
The problem today is primarily related to excessive debt leverage in the banking/financial system, which in many respects is a far more difficult problem to contain. Just go to Europe to see what that can do. A ten-year note in Greece is going for 30 pct. In Portugal, it is at 13 pct. The Euro is being kept alive literally by way of debt swaps and other types of financial triage. The crisis there is at the acute phase. In the case of the United States, capital is flowing back into the country, as the banking crisis in Europe intensifies and as the economy in exporting powers like China slows down. That's having the added effect of strengthening the dollar and lowering oil prices, at least in the short term.
Overall, we're still in the midst of a profound financial breakdown crisis, not the typical everyday postwar recession that we know. There's always an element of unpredictability here. A large bank failure in Spain or the United Kingdom, or Greece departing from the EMU can have downwind effects here.