Recently, my article on weak economic underpinnings led to an interesting exchange, via Twitter, with Steve Chapman regarding debt and the impact on economic growth.

The question is: Does rising debt cause slow growth or does slow growth cause debt to rise? https://t.co/CLDQnoyUBu

— Steve Chapman (@SteveChapman13) February 12, 2016

This question has been a point of contentious debate over the last several years as debt levels in the U.S. have soared higher.

According to Keynesian theory, some microeconomic-level actions, if taken collectively by a large proportion of individuals and firms, can lead to inefficient aggregate macroeconomic outcomes, where the economy operates below its potential output and growth rate (i.e. a recession).

Keynes contended that “a general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn resulting in losses of potential output due to unnecessarily high unemployment, which results from the defensive (or reactive) decisions of the producers.”  In other words, when there is a lack of demand from consumers due to high unemployment, the contraction in demand would force producers to take defensive actions to reduce output.

In such a situation, Keynesian economics states that government policies could be used to increase aggregate demand, thus increasing economic activity and reducing unemployment and deflation. Investment by government injects income, which results in more spending in the general economy, which in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment.

Keynes’ was correct in his theory. In order for government deficit spending to be effective, the “payback” from investments being made through debt must yield a higher rate of return than the debt used to fund it.

The problem is that government spending has shifted away from productive investments that create jobs(infrastructure and development) to primarily social welfare and debt service which has a negative rate of return.  According to the Center On Budget & Policy Priorities nearly 75% of every tax dollar goes to non-productive spending.