Interest rates

Federal debt when interest rates rise

When interest rates rise, by how much will the interest cost on the federal debt increase? The Federal Reserve is increasingly talking about scaling back its efforts to keep long-term interest rates low, the latest being the report of their meeting in September 2021. After they stop buying long-term securities, they are likely to raise short-term interest rates. When in a rush to change the economy, they change short-term interest rates by three percentage points in a year. The timing of an interest rate hike is uncertain, but the likelihood of an increase over the next two years is almost certain.

The federal government has approximately $ 22 trillion in publicly held debt. (Some of its debt is held in government trust funds, like Social Security, so the interest is both an expense and an income for the government.) Last year interest on debt amounted to $ 413 billion, with a low average interest charge of about 1.5%. (Calculating average interest is complicated by variable rate debt and inflation-adjusted debt, and the timing of debt issuance and maturities. This is a rough estimate.)

What if interest rates increased by, say, three percentage points for both short and long term interest rates? The short answer will seem to come from a proponent of larger spending: not too much. But the “not too much” answer comes against the backdrop of trillion dollar deficits, and more are on the way. As it turns out, interest charges aren’t the big item the United States needs to worry about.

The federal debt maturity date goes from next week to 2051. Thirty percent is due in the next 12 months, with another 13% in the following 12 months. It’s a big conundrum why, in an era of historically low interest rates and projections of high future deficits, the US Treasury did not lock in low interest rates by issuing more long-term debt and less. short term paper. Whatever the reason, our hypothetical interest rate hike will increase net interest charges on 43% of debt over the next two years, adding about $ 240 billion to federal spending. (The exact amount depends on the timing and timing of the new debt issuance.) Let’s round that off to a quarter of a trillion dollars. That’s real money but small compared to our overall spending, especially small after Congress passed multibillion-dollar budget reconciliation and infrastructure bills.

The rest of the world will not flee US debt, despite what appears to be an irresponsible level of borrowing. International investors do not ask themselves: “The American debt, yes or no? Instead, they ask themselves: “American debt or Chinese debt or French debt or Brazilian debt or…? In this context, we look pretty good. Global investors can diversify their assets across multiple countries, but they’re unlikely to avoid our holdings. This means that we will not have to pay an increased interest rate to borrow money.

Some people wonder if the Federal Reserve is really going to raise interest rates, given that it has so many bonds. Rising interest rates mean lower bond prices, so the Fed would have a loss on the securities it bought. However, the Fed is not at all motivated by the profits and losses of its own operations, and certainly not by the losses of paper. And treasury bills will all be repaid in full, even if the treasury has to issue new bills to repay old ones.

Current interest rate spending is not a huge burden relative to the size of our total federal revenues and expenditures, but that doesn’t mean the current path is sustainable. Eventually, excessive borrowing catches up with the spenders. We cannot know exactly when that day will come. This is unlikely to happen in the next few years, but it will certainly come if US taxes don’t get back on their feet.