Anticipated Curiosity Price Hike Will Add $2 Trillion to the Deficit

Even after the federal government was piling up massive deficits under Presidents Barack Obama and Donald Trump (and with the approval of both parties in Congress) during the 2010s, there was an emerging perspective among respected economists that challenged the traditional understanding of when the government should borrow and when it should pay down its debts.

Traditionally, during good times like the country enjoyed in the last decade—solid if not spectacular economic growth, relative peace, and historically low interest rates that made it easy for consumers and governments to borrow—policy makers would look to reduce spending and pay off debt. But those low interest rates created a new temptation. Maybe the government should just keep borrowing even when times are good?

“Sorry, deficit hawks: low interest rates are here to stay,” Alan Cole, a former senior economist with Congress’ Joint Economic Committee, titled a post on his Full Stack Economics blog in August 2021. “Countries, especially those that issue their own currency, can take advantage of low yields and borrow much more money at much lower rates than ever before,” he wrote, noting that low interest rates had persisted throughout the 2008 economic collapse and the first year-plus of the pandemic. “This is our new normal,” he argued, and market forces that might cause interest rates to return to levels seen in the 1990s were not likely “at least not in the next few decades.”

Cole was hardly alone. Larry Summers and Jason Furman, top economic advisors to the Obama administration, published a paper in 2020 arguing that deficit concerns had hamstrung the federal government’s ability to accomplish big things. As long as the cost of serving the federal debt remains below 2 percent, they argued, policy makers should not be restrained by the “traditional ideas of a cyclically balanced budget”—the idea that borrowing should rise in bad times and subside in good. Jared Bernstein, then a senior fellow at the progressive Center on Budget and Policy Priorities and now a member of President Joe Biden’s White House Council of Economic Advisers, went a step further. In an October 2020 op-ed for The Washington Post, Bernstein argued that the “new dynamics” of debt opened not only economic opportunities but political ones. Democrats should embrace borrowing as a way to deliver for their constituents, Bernstein wrote, and disregard the politically motivated worries of the budget hawks.

This perspective wasn’t limited to only liberals either. Larry Kudlow, a longtime conservative commentator and economic adviser to the Trump administration, dismissed Republicans’ deficit-inflating policies in 2019 by calling the national debt “quite manageable” and “not a huge problem at all” during an interview with C-SPAN.

It’s not quite fair to say that this emerging consensus believed the bill for heavy borrowing would never come due. More accurately, the argument was that the bill would always be reasonably affordable thanks to persistently low interest rates and that not spending the money would leave people worse off, so the added cost of borrowing would be worth it in the end.

That’s an argument that might need to be reconsidered.

On Wednesday, the Federal Reserve is reportedly expected to raise interest rates by 0.75 percent for the third time since June as the central bank continues to try to bring inflation under control. When the Fed hiked rates by 0.75 percent in June, Chairman Jerome Powell described that as “an unusually large” bump. It has become worryingly routine.

As a consequence of the sudden jumps in baseline interest rates, all types of borrowing are getting more expensive. That’s especially true for the federal government, because most federal borrowing is executed on a short-term basis rather than being fixed for a longer period, as mortgages usually are.

Tomorrow’s rate hike will add an estimated $2.1 trillion to the federal deficit over the next two years, according to an analysis from the Committee for a Responsible Federal Budget (CRFB), a nonprofit that advocates for lower deficits. That’s $2 trillion that goes on the tab to be repaid even though no one ever benefitted from it. It helped to build no bridges, feed no hungry people, or make any business more profitable.

Even with low interest rates, the cost to service the size of the national debt was expected to balloon during the next few decades. Other than the cost of entitlements like Social Security and Medicare, the interest costs are the biggest driver of America’s long-term deficit. Higher interest rates will compound that problem, as the CRFB has been detailing for months.

Biden and Congress have made the situation yet worse by continuing to borrow and spend even long after it became obvious that interest rates would have to rise to combat inflation caused in part by all the borrowing and spending. Despite what the White House claims, Biden has approved more than $4.8 trillion in new borrowing to finance the American Rescue Plan, student debt relief, and other initiatives.

“The progressives demanding new debt-financed programs to take advantage of low interest rates did not acknowledge that Washington is already on course to borrow $114 trillion over 30 years just to finance current programs,” Brian Riedl, a senior fellow at the conservative Manhattan Institute and a former Senate Republican budget staffer, tells Reason. 

“Essentially, Washington is committing to trillions in new, permanent debt obligations based on short-term adjustable interest rates,” Riedl says. “Anyone with a mortgage can tell you how insane that is.”

What the Biden administration and Democrats in Congress have done during the past 20 months is, in short, follow the outline drawn up by Cole, Furman, Bernstein, and others. As long as interest rates remain low, the argument went, the federal government would always be able to afford to keep borrowing. Interest rates didn’t stay low.

Sorry, but the deficit hawks might have been right.

The post Expected Interest Rate Hike Will Add $2 Trillion to the Deficit appeared first on Reason.com.

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