Don’t look now, but America’s tab for paying interest on the national debt is rising fast. You can thank Federal Reserve Chairwoman Janet Yellen and President-elect Donald Trump—in that order. And it’s bringing to an end a remarkable chapter in America’s fiscal history.
First, Yellen: On Wednesday, she announced that the Federal Reserve is raising the key short-term interest rate it controls for only the second time in a decade. The Fed is raising the target for the federal funds rate from .25–.50 percent to .50–.75 percent. This is part of the Fed’s long-awaited effort to normalize interest rates as the economy continues to recover. It may not sound like much, but when rates are this low, any move is significant. The rates on the short-term debt the U.S. government issues, from seven days up to two years, closely track the Fed Funds rate. Since October 2015, the cost for America to borrow money for a year has risen from .25 percent to .92 percent—a 268 percent increase.
For the past several years, American taxpayers have been spoiled by very low interest rates. As spending increased and tax receipts collapsed during the recession, the annual federal budget deficit soared to $1.4 trillion in 2009. Thanks to years of austerity budgets, modest tax increases, and persistent growth, the annual deficit in 2016 clocked in at $587 billion, a manageable 3 percent of GDP. The cumulative effect of the years of deficit has boosted the total national debt from $10.6 trillion at the beginning of 2009 to $19.9 trillion today.
And yet America’s net interest tab—the amount it pays in interest on bonds owned by investors minus the amount of interest it receives on bonds owed to Social Security recipients—has actually remained stable. In 2008, net interest on the federal debt was $252 billion; in fiscal 2016, which ended in September, it was $240 billion. We’ve been able to get our hands on the money of others cheaply.
The reason is twofold. First, the Fed lowered short-term interest rates to zero and held them there until a year ago, making short-term borrowing costs extremely low. At the same time, the grueling legislative combat in D.C. after Republicans regained control of Congress in 2010—the refusal to do further stimulus, the sequester, Obama’s insistence on the expiration of portions of the Bush tax cuts—helped hold down long-term growth. And that kept long-term interest rates low.
In the past year, both those pillars of low borrowing costs have fallen—slowly and then all at once. At the end of 2015, Yellen boosted the target Federal Funds rate from a target of .00–.25 percent to .25–.50 percent. And throughout 2016, as investors anticipated further hikes, short-term rates on government debt drifted higher.
Second, Donald Trump unexpectedly won the election and Republicans maintained control of both houses of Congress. And that has pushed long-term interest rates much higher. Why? Investors believe, probably correctly, that neither Trump nor Republicans really care about deficits or fiscal probity. And so we’re likely to get big tax cuts and more spending on infrastructure and defense without big spending cuts. The upshot: More rapid growth, a greater likelihood of inflation, and the need of the government to issue higher volumes of debt. All of those factors have pushed interest rates up. Since Nov. 4, the yield on the 10-year U.S. government bond has soared from 1.78 percent to 2.52 percent—an increase of 41 percent.
The U.S. government operates a giant floating-rate borrowing operation. Every week, as bonds and bills mature, it sells new debt. In the fourth quarter of 2016, Treasury expects to sell well over $1 trillion in debt instruments. Now, because the Fed is pushing short-term rates higher and the Trump effect is pushing long-term rates higher, pretty much every penny of that amount will be sold at a higher rate than the old debt it replaced. All of which may serve to constrain Republican ambitions and Trump’s ability to deliver on his many promises. Every penny eaten up by interest on the national debt, which must be paid, is one less penny for tax cuts, for the construction of bridges, or for veterans’ health care.
Before Yellen’s most recent move and the election, the Office of Management and Budget was already expecting the net interest tab to spike in the coming years—from $240 billion in fiscal year 2016 to $302 billion in fiscal year 2017 (an increase of $62 billion, or 26 percent), and to $385 billion in fiscal year 2018. That represents an increase of $140 billion, or 60 percent, in just two years. And keep in mind, those forecasts don’t anticipate the results of any significant changes.
It’s a good thing our president-elect has never had a problem making interest payments.
