October 1, 2014

Rising Interest Rates Could Add to Budget Pressures

  • The national debt has grown significantly in recent years due to rising annual deficits. A deficit occurs in any year the government spends more...

After a long period of abnormally low interest rates, their recent uptick has led to considerable volatility in the credit markets and has renewed concerns about an increase in borrowing costs for the federal government.

The good news is that rising rates signal a strengthening economy. In Washington, however, low borrowing costs have given elected officials a cushion that has allowed them to put off difficult choices about long-term fiscal priorities.

As interest rates increase, projected borrowing costs will swallow up budgetary resources -- growing more rapidly than any other budget line-item over the next decade.

In updating its budget projections last month, the Congressional Budget Office (CBO) assumed “an anticipated substantial rise in interest rates as the economy strengths.” The budget office said this, together with continued growth in the federal debt, will “sharply boost interest payments.”

Under current law, CBO projects, “the government’s net interest spending will more than double as a share of GDP in the coming decade – from 1.4 percent in 2014 to 3.2 percent in 2023, a percentage that has been exceeded only once in the past 50 years.”

But such projections involve considerable uncertainty, and a variety of factors – including future government borrowing -- could lead to even higher interest rates than anticipated. Last year the CBO calculated that if interest rates were one percentage point higher than it assumed for a decade, it would cost taxpayers an additional $117 billion.

On the positive side: Washington has the ability to rein in future borrowing costs through fiscal reforms that reduce its deficits and eventually stabilize the federal debt. As interest rates continue to rise, however, procrastination will become more and more expensive.