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  • Jonathan Poyer

The Terror Of Rising Rates On Federal Debt

The Department of the U.S. Treasury released their monthly report. Good and interesting stuff (only a $220,000,000,000 deficit in the month of August). But right off the bat, check out the interest on the debt number:

YTD, that net interest outlay through August has been $471,000,000,000.

For perspective, interest payments in January were $34 billion, close to half of what Treasury paid in August. Another way of appreciating the size of August’s interest payments is to annualize the figure: $756 billion is 3 percent of GDP.

Half of our debt has a maturity of 3 years or less, and 3-year treasury notes are currently yielding 3.79 percent — up from 0.4 percent a year ago.

What happens as that debt needs to be re-issued and rolled forward but at higher and higher interest rates?

Even interest rates of 5% could push the national debt toward 300% of GDP within three decades.

Check out the CBO's estimates of interest rates paid on the debt:

After the 1980s, the federal government by 1990 had paid an 8.4% average interest rate on the debt held by the public. The average rate had gradually declined to 4.9% by 2006, before the GFC dropped rates further, to approximately 2.0%, where they remained until a recession and pandemic decreased average debt maturities and dropped the average federal rate to its current levels.

U.S. interest rates fell during a period in which the federal debt held by the public increased from 40% to 100% of GDP.

Look at how the CBO forecasts debt payments into the future. The CBO baseline below assumes that the average interest rate paid on the federal debt gradually rises from 2.4% to 4.6% between 2019 and 2051. The CBO baseline assumes that, by 2051, interest on the national debt will cost 8.6% of GDP (the current equivalent of $1.9 trillion annually).

An analysis of CBO data reveals that every percentage point by which interest rates exceed the CBO projected rates would increase government interest costs by $30 trillion over 30 years. Even this 1-percentage-point additional rise in interest rates would push the projected debt to 243% of GDP in 30 years. By that point, annual deficits would jump to 17.6% of GDP, with interest costs consuming 13.0% of GDP, or 70% of all tax revenues. A 2-percentage-point overage would push the debt to nearly 300% of GDP within three decades, with interest consuming 100% of all tax revenues.

Looking at CBO forecasts for how interest rates will impact the Government's interest payments:

This is a dangerous game we are playing. Deficits and interest rates have big time consequences. As the Fed raises rates to fight inflation, we are looking at biological consequences where the changing of variables and inputs have effects far beyond what can be easily seen, calculated, or measured.

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