March 27, 2013, 11:46 AM
If Rates Rise, Larger Deficit Follows
By David Wessel
Big borrowers are very sensitive to interest rates. The federal government is a big borrower. Even at today’s super-low interest rates, Washington spends a lot of money on interest — more than 6% of all federal spending last year.
And it will spend more on interest as rates move back toward normal, as they surely will someday. The Congressional Budget Office expects rates on three-month Treasury bills (now close to zero) to be at 4% in 2023 and rates on 10-year Treasury notes (now around 1.9%) to at 5.2% in 2023. If current budget policies persist, more than 14% of federal spending will go to pay the interest tab.
What if rates go higher than that? In response to a query from a member of Congress, CBO has done some calculations.
If interest rates rise to the averages seen between 1991 and 2000 — that is, 4.9% on the 3-month Treasury bill and 6.7% on the 10-year Treasury note in 2023 — then the deficit would be $274 billion bigger in that year than it would otherwise be — and $1.44 trillion bigger over 10 years.
Or, in a slightly different scenario, if interest rates rise as the highest 10 predictions of the private-sector economists surveyed by the Blue Chip Economic Indicators — that is, 4.5% on the 3-month Treasury and 5.8% on the 10-year in 2023 — then the federal deficit will be $157 billion bigger in that year then it would otherwise be, and $1.14 trillion bigger over ten years.
Of course, interest rates depend on inflation and on the strength of the economy and on Federal Reserve policy, all of which would have big effects on the budget.
But the point is clear: A government that borrows a lot will spend a lot more on interest when rates return to normal. And because about half of all U.S. government debt is now held overseas, that means a lot of that interest would be paid for foreigners, particularly the Chinese and Japanese.
And it will spend more on interest as rates move back toward normal, as they surely will someday. The Congressional Budget Office expects rates on three-month Treasury bills (now close to zero) to be at 4% in 2023 and rates on 10-year Treasury notes (now around 1.9%) to at 5.2% in 2023. If current budget policies persist, more than 14% of federal spending will go to pay the interest tab.
What if rates go higher than that? In response to a query from a member of Congress, CBO has done some calculations.
If interest rates rise to the averages seen between 1991 and 2000 — that is, 4.9% on the 3-month Treasury bill and 6.7% on the 10-year Treasury note in 2023 — then the deficit would be $274 billion bigger in that year than it would otherwise be — and $1.44 trillion bigger over 10 years.
Or, in a slightly different scenario, if interest rates rise as the highest 10 predictions of the private-sector economists surveyed by the Blue Chip Economic Indicators — that is, 4.5% on the 3-month Treasury and 5.8% on the 10-year in 2023 — then the federal deficit will be $157 billion bigger in that year then it would otherwise be, and $1.14 trillion bigger over ten years.
Of course, interest rates depend on inflation and on the strength of the economy and on Federal Reserve policy, all of which would have big effects on the budget.
But the point is clear: A government that borrows a lot will spend a lot more on interest when rates return to normal. And because about half of all U.S. government debt is now held overseas, that means a lot of that interest would be paid for foreigners, particularly the Chinese and Japanese.
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