Expected Interest Rate Hike Will Add $2 Trillion to the Deficit

Reputable economists have begun to challenge the old understanding about when and how the government should borrow.

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. These low interest rates have created an opportunity for new temptations. Perhaps the government shouldn’t stop borrowing, even when things are going well?

“Sorry to deficit hawks; low interest rates have here to stay,” Alan Cole, an ex-senior economist in Congress’ Joint Economic Committee, wrote in his post Full Stack Economy Blog August 20,21. “Countries can benefit from low yields and borrow more money than ever before,” he said, noting that low rates of interest had been around since 2008, when the global economic crisis hit. This is the new normal, he said. Market forces that could cause interest rates back to 1990 levels were unlikely “at most not for the next few generations.”

Cole was not the only one. Jason Furman and Larry Summers, the Obama’s top economic advisers, wrote a 2020 paper arguing that federal deficit worries had hindered the government from achieving big goals. 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 is now an economist and senior fellow of the Center on Budget and Policy Priorities. He was also a member of President Joe Biden’s White House Council of Economic Advisers. A October 2020 opinion-ed by The Washington Post Bernstein stated that “new dynamics of debt” opened up political opportunities as well as economic ones. Bernstein wrote that Democrats must embrace borrowing as a means to serve their constituents. He also suggested that Democrats ignore the concerns expressed by budget hawks because they are politically motivated.

This outlook wasn’t just for liberals. Larry Kudlow is a veteran conservative commentator, economic adviser, and economist to Trump. Kudlow called Republicans’ deficit-inflating strategies in 2019 “quite manageable”, and “not an enormous problem at all” during a C-SPAN interview.

This consensus was not necessarily saying that heavy borrowing bills would never be issued. The argument was more accurate: the bill would be affordable due to the persistently low interest rate and the fact that it is not expensive. It is not The cost of borrowing money is worth the risk as it would make the people less fortunate.

This argument might be worth reconsidering.

As the Federal Reserve continues to fight inflation, it is expected that Wednesday’s interest rate hike by 0.75 percent will be made. Jerome Powell called it “unusual” that the Fed raised interest rates by 0.75 percentage in June. It is now a worrying daily occurrence.

Due to sudden rises in the baseline interest rate, borrowing is getting more expensive. The federal government is particularly affected by this because federal borrowing tends to be short-term rather than long-term. Mortgages are usually fixed for longer periods.

Tomorrow’s rate rise will be add an estimated $2.1 trillionAccording to an analysis by the Committee for a Responsible Federal Budget, a non-profit that promotes lower deficits, the federal deficit will increase over the next two year. This is $2 trillion in debt that must be paid even though it has never been used. This money did not help to create bridges or feed the hungry, nor make businesses more profitable.

The cost of service to the country’s national debt is expected to increase even with low interest rates. The largest driver of America’s long-term deficit is not the cost of entitlements such as Medicare and Social Security, but the interest rates. As the CRFB has detailed for many months, higher interest rates will only exacerbate this problem.

Congress and Biden have worsened the problem by borrowing and spending long after inflation was averted. The White House denies that Biden approved $4.8 trillion of new borrowing in order to fund the American Rescue Plan and student debt relief.

“The progressives requesting new debt-financed programmes to benefit from low interest rates didn’t acknowledge that Washington is currently on track to borrow $114 trillion over the next 30 years to finance its current programs,” Brian Riedl (a senior fellow at The conservative Manhattan Institute, and former Senate Republican staffer) tells. Reason. 

Riedl says that Washington is actually committing trillions to new permanent debt obligations on the basis of short-term adjustable rates. Everyone with a mortgage knows how absurd this is.

The Biden administration, along with Democrats in Congress, have followed the plan laid out by Cole, Furman and Bernstein over the last 20 months. The argument was that the federal government could continue borrowing as long as interest rates are low. Interest rates didn’t stay low.

We are sorry, the deficit hawks may have been correct.