February 26, 2018

Rising Interest Rates Would Explode the Federal Debt

As the federal government prepares its budget for the new year, it will need to yet again fund its deficit spending. The Treasury does this by issuing bonds to the public. Because Treasury bonds are considered safe investments, the interest rate is typically lower than that of private-sector securities. The difference between the interest rates of private securities and Treasury bonds is referred to as a “spread.” A higher spread means lower interest rates from federal Treasury bonds as compared to private securities.

In 2014, the Congressional Budget Office (CBO) estimated how big the spread would be for bonds paid by 2039 and calculated how the federal budget would be affected by a spread that tracks the historical baseline, one that is 0.75 percent greater than the baseline, and one that is 0.75 percent smaller. CBO’s baseline estimate for the cost of interest payments on federal debt is 5.2 percent of GDP in 2039. An increase in the spread would lower these payments, while a decrease would raise the portion of GDP required to be paid.Interest rates tend to rise as borrowing increases. Given that Congress already borrows money each year to pay for federal spending, and given that the projections show this trend will not stop any time soon, more borrowing now will mean greater future spending. Without increasing revenues, a larger national debt looms in the long term. This is demonstrated by CBO’s data on the effects of bond interest rates on debt as a share of GDP by 2039.It is important to note that deficit projections have changed since 2014, which is when the estimates were calculated. The federal government is now projected to need to borrow even more, and interest rates would likely need to rise to attract the necessary lenders, leading to an even larger share of GDP taken in servicing the debt and the debt itself rising faster.