Interest on public debt increases the risk of a fiscal crisis
Over the next 30 years, the fastest growing category of government spending is expected to be interest on the national debt. This means that the government will shell out hundreds of billions of dollars more each year for interest payments.
The growth in interest charges presents a huge threat to the economy and the economic future of Americans. The long-term societal effects will be massive; it will be a painful calculation when the bill is due.
According to Congressional Budget Office (CBO) Long-Term Budget Outlook for 2022the cost of interest on the national debt will exceed defense spending in 2029; Medical help, Health Insurance and Health insurance for children in 2046; and Social Security in 2048.
The CBO has forecast that annual interest charges paid to holders of Treasury securities will total $399 billion in 2022 and triple over the next decade to $1.2 trillion, from 1.6% of proceeds gross domestic (GDP) at 3.3% in 2032, which would be the highest level ever.
If the Federal Reserve increases interest rates by larger amounts than the CBO predicted, costs could rise even faster than expected. In addition, interest expense is on track to become the federal government’s largest expense in 2054. By then, interest expense will account for nearly 40% of tax revenue and will become the single largest federal expense.
Rising interest payments are the result of escalating interest rates and debt levels that have risen like the blade of a hockey stick. Treasury yields have jumped with rampant inflation and the Federal Reserve in aggressive tightening mode, while the national debt has risen by some $6 trillion since the start of the pandemic. Fiscal and monetary policies induced by the pandemic have changed the debt situation considerably and for the worse.
The latest data shows inflation at an annual rate of 8.5%. It is reasonable to expect the Fed to continue tightening for an extended period, trying to reduce aggregate demand, ease pressure on consumer prices and produce the desired soft landing. In 2017, the national debt was $20 trillion; now it is approaching $30 trillion. Ten-year Treasury yields climbed nearly 3%, double what they were last December.
Rising debt and high interest rates can crowd out important federal budget priorities and lead to a vicious cycle of even more debt, deficits and interest payments. This means that the government will pay hundreds of billions of dollars more each year in interest payments on top of other fixed costs that are also rising, such as health and pension benefits for an aging population. This increases the risk of a fiscal crisis.
As for those who cling to the hope that people in Washington will develop a long-term strategy to deal with debt and deficits, it’s probably time to call that wishful thinking.
Congresses and presidents of both parties have long avoided making tough choices about the federal budget and failed to put it on a sustainable path.
In accordance with centuries-old tradition, they prefer to simply enter the National Arboretum of Magical Money Trees and grab what they want. The phrase “often wrong, but never in doubt” is only a slight exaggeration when it comes to their behavior. The present holds their attention. The few lawmakers who raise questions about debt, deficits and rising interest costs are an endangered species.
Of course, crises can provide the cover needed to make tough and difficult decisions. As Stanford professor Paul Romer said in 2004, a crisis is a terrible thing to waste – a sentiment later echoed by former White House chief of staff Rahm Emanuel. Hope the US doesn’t waste this one.
Joseph M. Giglio is a professor of strategic management at Northeastern University’s D’Amore-McKim School of Business.