the Federal Reserve is leading a ruthless campaign to crush stubbornly high inflation with the most aggressive interest rate hikes in decades.
While most of the recent attention on the US central bank has focused on whether policymakers will manage to lower prices without dragging the economy into recession, there is another important consequence of higher interest rates: the potential damage to US government finances.
This is because as interest rates rise, so will the borrowing costs of the federal government on its $30.89 trillion debt.
According to the Congressional Budget Office, interest payments on the national debt are already projected to be the fastest growing part of the federal budget in fiscal year 2022. Payments are expected to triple from nearly $400 billion in the fiscal year 2022 to a staggering $1.2 trillion in 2032, a total of $8.1 trillion over the next decade.
As part of the economy, the total interest on the national debt will reach a record 3.3% of GDP, the broadest measure of goods and services produced in the country, by 2032, the CBO estimated.
In reality, the payouts could be even higher; current interest rates are already higher than those included in the May CBO estimate, according to the Committee for a Responsible Federal Budget, a nonpartisan group that advocates for reducing federal debt.
Fed policymakers have already approved four straight rate hikes this year, including two large 75 basis point hikes in June and July, signaling they are nowhere near stopping in their quest to squash runaway inflation. . The central bank is widely expected to approve another three-quarters of a percentage point hike at its meeting next week, or even vote to raise rates by a historic full percentage point.
The current benchmark federal funds range of 2.25% to 2.50% is around the “neutral” level, meaning it neither supports nor constrains economic activity. However, Fed Chairman Jerome Powell has suggested a tightening stance will almost certainly be necessary as the central bank tries to rein in the economy.
“The Fed has and accepts responsibility for price stability,” Powell said last week at the Cato Institute’s 40th Annual Monetary Conference. “We need to act right now, frankly, forcefully.”
For years, the US has been able to borrow cheaply as interest rates have remained historically low. However, as the fed funds rate rises, so will short-term rates on Treasury securities, making federal borrowing more expensive.
“Growing interest costs also presents a significant long-term challenge,” said the Peter Peterson Foundation.
CBO projections show that interest payments could add up to nearly $66 trillion over the next 30 years, eventually accounting for nearly 40% of all federal revenue by 2052. Interest costs would also become the biggest “program” for decades to come. surpassing defense spending in 2029, Medicare in 2046, and Social Security in 2049.
“As interest rates rise and the nation’s debt grows, it will become even more expensive to borrow in the future. Congresses and presidents of both parties, for many years, have avoided making tough decisions about our budget and failed to bring it to a sustainable level. It is vital that lawmakers take action on mounting debt to ensure a stable economic future,” said the Peter Peterson Foundation.
The national debt is projected to hit $31 trillion as early as this month amid a flurry of new spending by President Biden and Democratic lawmakers. Biden signed into law a health care spending and climate change bill, called the Reduce Inflation Act, in early August that would spend an estimated $739 billion over the next decade. Most of that revenue comes from new revenue generated by higher taxes; about half is scheduled to pay down debt.
That was offset, however, by Biden’s decision last month to write off $10,000 in student loan debt for millions of low-income Americans and $20,000 in debt for Pell Grant recipients. Estimates have suggested the policy could cost as much as $1 billion.