Changes in Borrowing Costs Can Have a Dramatic Impact on the Federal Budget

Blog Post
Thursday, November 02, 2017

The federal government, like all entities that borrow money, pays for the privilege of doing so in the form of interest. A growing national debt therefore places a greater burden on the federal budget in the form of rising interest costs. The Congressional Budget Office (CBO) projects that under current laws, over the next decade the government will spend over $5 trillion solely to pay the interest costs for past borrowing.

This figure, however, is subject to change based on two key variables. The first is the size of the national debt on which the government is paying interest. The second variable is the interest rate, which determines how much the government must pay for each dollar of outstanding debt.

Interest rates can change substantially and have dramatic impacts on the federal budget. When The Concord Coalition was founded in 1992, interest rates were much higher than they are today. That year, federal interest costs equaled 3 percent of GDP (gross domestic product). In 2017, that figure was just 1.4 percent of GDP -- despite the fact that the national debt as a percentage of GDP has grown by more than half since 1992.

While unusually low interest rates have benefitted the federal government’s balance sheet in recent years, over the next decade, annual interest costs are projected to nearly double as rates return closer to their historical levels. For example, the interest rate paid on a 10-year treasury note is right now roughly 2.4 percent (substantially below the 1990’s average of about 6.7). Over the next decade, that is projected to rise to around 4 percent. And if interest rates were just one percentage point higher than CBO’s current projections, federal interest payments would cost an additional $1.6 trillion over the next 10 years. That’s almost enough to pay for the entire military budget for three years.

The larger the national debt, the greater danger a sudden swing in interest rates would pose. The worst situation would be one in which growing debt and rising interest rates feed into a vicious cycle. Lenders could demand higher interest rates to compensate for concerns about the unsustainable debt. The resulting higher interest costs would be paid with additional borrowing, which would lead to more debt and further increases in interest costs -- a vicious cycle.

Even if this worst-case scenario never came to fruition, rising interest rates could still result in ballooning interest costs that crowd out other critical federal investments as they compete for limited resources. It is thus critical that policymakers protect the nation from rapidly rising interest rates by controlling the growth of the nation’s debt burden.