Lawmakers must address the country’s longterm fiscal situation. The Fed raised rates to address inflation, but the cost of borrowing is huge

If interest costs remain high, so will the risks of inaction



October 11, 2023 - 2:45 PM

Janet Yellen, US secretary of the treasury

Borrowing is expensive again, as anyone who has tried to buy a car or home lately can tell you. The interest rate on 10-year Treasury bonds, the benchmark for home loans, is hovering around 4.75%, a nearly two-decade high. This will significantly add to the federal government’s expenses and raises the urgency to lower the deficit. Interest costs are already the fastest-growing part of the budget. Net interest costs — a nonnegotiable expense — nearly doubled as a share of federal outlays between 2020 and 2023, going from $345 billion, or 5%, to $660 billion, or 10%. (Defense, by comparison, cost $815 billion, or 13%of spending in 2023.)

The higher rates partly reflect the Federal Reserve’s necessary campaign against inflation, but they also mean that the miracle of compounding is now working against the country’s fiscal stability. Barring policy changes, recent interest rate increases could add $3 trillion over the next decade to interest costs, according to Marc Goldwein, senior policy director for the Committee for a Responsible Federal Budget.

In addition to financial danger, there’s irony here: While millions of Americans bought or refinanced homes at mortgage rates below 4% in recent years and locked those cheap rates for 30 years, the U.S. government failed to do so. Top Democratic economists such as Janet L. Yellen and Lawrence H. Summers urged a government borrowing spree during a period of seemingly permanent low interest rates before 2020. They argued it was wise to borrow long-term and invest in productivity-enhancing infrastructure and education, as well as the green transition. The government did indeed borrow massively in 2020, but largely to keep businesses and consumers solvent during the pandemic. The Biden administration and Congress have subsequently made investments but were unable to lock in low rates for decades. The average maturity in the federal debt portfolio is about six years, meaning a huge chunk of government debt must soon be refinanced at high rates. Consider the three-month Treasury bill. The yield on that was almost zero in 2021. Now, it’s more than 5%.

There was already a critical need for Congress and President Biden to start addressing the long-term fiscal situation through some combination of higher taxes, moderate expense cuts, and adjustments to Social Security and Medicare. We laid out a plan earlier this year to stabilize the debt. The sobering new interest-rate reality makes it even more pressing. Indeed, the infamous crowding-out effect from large federal debts might start making a comeback. Instead of providing capital to invest in private business, directly or through the stock market, people with extra cash are likely to choose to earn high rates on less risky government debt. This could hurt U.S. growth. One sign that investor caution, and not just Fed policy, is at work: Interest rates on government debt have continued to rise well after the Fed’s last hike, which occurred in July.

With the House of Representatives in chaos, perhaps the best hope is for a bipartisan group of senators to launch a debt commission to generate a plan. It might not get taken seriously for a while with the 2024 election looming. But if interest costs remain high, so will the risks of inaction.