Higher National Debt Means Higher Interest Rates for the Federal Government
Last Updated May 6, 2019
The amount spent by the federal government on interest is large and growing. Recent Congressional Budget Office (CBO) projections show that net interest will become the third largest “program” in the budget by 2025. Such spending clearly contributes to our growing national debt, but the escalation in the debt itself can boost interest rates and, in turn, further add to the interest burden. Recent research from CBO quantifies the relationship between rising debt and applicable interest rates.
CBO’s research found that over the long-term, an increase in the debt-to-GDP ratio of 1 percentage point is associated with an increase in inflation-adjusted 10-year interest rates of .02 to .03 percentage points. The debt-to-GDP ratio is currently projected to rise by about 14 percentage points over the next 10 years. Therefore, CBO’s findings suggest that by 2029, interest rates on 10-year Treasury Notes could be roughly 0.3 to 0.4 percentage points higher than they would be in the absence of a debt increase.
CBO’s paper also shows that the effect of debt on interest rates varies depending on the specific type of fiscal policy that leads to the increase in debt. Fiscal policies with a positive effect on the supply of labor or capital will lead to a smaller interest rate increase than policies that do not have such an effect. Policies with a positive impact on labor or capital can come from either side of the budget — examples include spending on infrastructure and reducing distortionary taxes.
CBO’s findings about the relationship between debt and interest rates are just one more reminder that we need to address our unsustainable fiscal outlook. With interest costs occupying a growing share of our budget each year, it will become even more difficult to make pivotal investments in education, research, and infrastructure. To make sure that there is room in the budget for those investments, as well as for other national priorities, we need to mitigate the squeeze that rising debt — and therefore interest costs — place on the budget.
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Further Reading
Long-Term Budget Outlook Leaves No Room for Costly Legislation
As lawmakers consider costly legislation to extend expiring tax provisions this year, CBO’s latest projections serve as a warning that our fiscal outlook is already dangerously unsustainable.
Moody’s Warns Recent Policy Decisions Worsen U.S. Fiscal State, Maintains Negative Outlook Rating
Moody’s says that the United States is in fiscal deterioration, warning that government policy decisions in the near term could contribute to higher interest rates and worsening national debt.
National Debt Would Skyrocket Under TCJA Extension
New analysis released from the nonpartisan CBO shows deficits doubling and debt skyrocketing under a scenario where the expiring provisions of the Tax Cuts and Jobs Act were made permanent.