The latest NBER paper by Vadim Elenev, Tim Landvoigt and Stijn van Nieuwerburgh puts a precise name and number on something policymakers have been pretending not to see. They call it the austerity threshold: the debt-to-GDP ratio beyond which the U.S. government can no longer rely on patience, rhetoric or financial repression to keep its bonds safe. Beyond that line, fiscal surpluses must rise through either spending cuts or tax hikes if default in real terms is to be avoided.
The paper’s model, calibrated to U.S. data and incorporating realistic risk premia, nominal rigidities and a financial sector that values Treasuries for their liquidity, locates the threshold around 189% of GDP if austerity comes through higher taxes, and 174% if it comes through spending cuts. This is a sobering framework because it clarifies that fiscal capacity is not infinite even when the safe rate is below the growth rate. The safety and convenience premia that depress Treasury yields erode as debt rises; the very forces that have made deficits look cheap are self-limiting.
The Illusion of Infinite Capacity
For years, advocates of debt-financed policy have taken comfort in a world of r < g, where r is the rate of interest on the debt and g is the rate of economic growth. As long as the economy grows faster than the interest bill, they argue, why worry?
Elenev and his coauthors show why that logic eventually fails. When risk premia and liquidity demand are modeled realistically, the government’s borrowing advantage shrinks with each new debt issuance. The more Treasuries in circulation, the less “special” they become. The market’s willingness to treat them as pristine collateral is not a law of nature; it is a convenience subsidy that can be spent down.
Even in a world of low real rates, fiscal capacity is finite. The United States is already halfway to its limit.
The Two Roads to Austerity
The paper distinguishes between two kinds of fiscal adjustment. A tax-based correction behaves like a supply shock: It reduces labor supply, drives up inflation and forces the Fed to tighten. A spending-based correction is a demand shock: Inflation falls, the Fed can ease, and output recovers more quickly.
Both routes stabilize debt, but the choice between them matters. One fuels inflation; the other quenches it. One crowds out work; the other crowds in investment. Markets price these expectations well before the threshold is reached, which means the debate about which path to choose affects bond yields now, not later.
The Politics of Uncertainty
Where the paper becomes most interesting and most realistic is in its treatment of political uncertainty. Suppose investors cannot tell whether future austerity will come from tax hikes or spending cuts. In that case, fiscal capacity collapses to around 120% of GDP. A country that could once sustain 180% debt becomes fragile at barely two-thirds that level.
Why? Because regime uncertainty makes the debt itself volatile. A sudden shift from expected tax austerity (inflationary) to spending austerity (disinflationary) would reprice Treasuries upward, raising their market value and, paradoxically, the measured debt ratio. When the stock of debt is already huge, even a benign repricing can push it into territory no policy can stabilize. Ambiguity about the future, in other words, destroys fiscal space in the present.
Echoes of September
I wrote in September that “under the most optimistic assumption—markets believing Congress will eventually stabilize—U.S. debt cannot sustainably exceed 200 percent of GDP. … [T]he danger zone is somewhere in the 175–190 range.” There I was describing the same geometry this paper formalizes. The optimistic ceiling is not a promise; it is a stress test of belief. Once that belief weakens, once investors doubt that fiscal restraint will arrive on time, yields can jump and the safe-debt illusion can shatter.
Elenev, Landvoigt and Van Nieuwerburgh give that intuition a quantitative backbone. They show that fiscal space is not a simple function of r–g; it is the equilibrium outcome of risk, regulation and political credibility. Lose any one of those and the capacity line plunges.
The Fragile Barrier
The deeper lesson is that America’s fiscal future hinges less on arithmetic than on expectation. Market confidence (an intangible, reversible thing) remains the only barrier between today’s complacency and tomorrow’s crisis.
The austerity threshold is not a cliff we can see coming; it is a line that appears only when crossed. And by the time we recognize it, the comforting arithmetic of r < g will have been replaced by something far more familiar: r > g, inflation rising and policymakers discovering that the laws of finance were never suspended after all.