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The Sustainability of the Federal Budget Deficit: Market Confidence and Economic Effects

Contents
Introduction ...................................................................................................................................... 1
At What Point Does the Public Debt Become Unsustainable? ........................................................ 1
     Are Financial Markets Treating the Debt as Unsustainable? ..................................................... 2
     Evidence from Abroad ............................................................................................................... 3
     Will Future Budget Deficits Remain at Unsustainable Levels Under Current Policy? ............. 5
     Sustainability and Foreign Holders of the Debt ........................................................................ 6
Economic Effects of a “Debt Spiral” ............................................................................................... 8
     Would a Failure to Raise the Debt Limit Cause a Debt Spiral? .............................................. 10
     Would a Ratings Downgrade Cause a Debt Spiral? ................................................................ 12
Is a Large But Manageable Deficit Harmful to the Economy? ...................................................... 13
     Will Large Deficits Lead to High Inflation? ............................................................................ 15

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