Consumers and businesses aren’t the only ones feeling the pain of higher borrowing costs because of Federal Reserve rate hikes. Uncle Sam is too.
The U.S. government spent a record $213 billion on interest payments on its debt in the fourth quarter, up $63 billion from a year earlier. Indeed, a jump of almost $30 billion from the previous quarter represents the biggest quarterly jump on record. That comes as the Fed lifted interest rates a whopping 4.25 percentage points from March through December.
I am concerned that the effect of higher interest payments on the government’s budget is being ignored. Higher interest payments mean the federal government will either have to lower spending, raise taxes or issue more debt to service its obligations. And financing interest payments by issuing more debt could be a particularly poor choice.
The national debt increases when spending is greater than revenue and accumulates over time. As a general rule, it increases over time because of increases in spending, revenue and the deficit. Inflation tends to increase government spending, as well as revenue and deficits. As a result, the dollar value of government debt increases in times of inflation. Debt also tends to grow as the economy gets bigger – although this is not inevitable.
Total government debt has climbed over the years – by the end of 2022 it was 10 times larger than it was in 1990. It currently stands at over $31 trillion and represents more than 120% of the nation’s gross domestic product.
Since 1990, government debt has more than doubled relative to the size of the economy. But how concerning are these numbers?
Government borrowing has some similarities to a person paying for an expensive item with a credit card, with the actual amount due to be paid off over an extended period.
In terms of interest payments, the U.S. has been fortunate in recent years. Historically low interest rates since the 2008 financial crisis have held down interest payments. Those rates have also made it much more attractive for the federal government to borrow money to pay for whatever Congress and the administration want to finance.
But then came 2022. Soaring inflation meant an end to the days of near-zero interest rates. To restrain inflation, the Fed raised rates seven times in 2022, taking the base rate from near zero to a range of 4.25% to 4.5% at the end of 2022. Projections made by Federal Board members indicate that, with future increases, rates will average 5% or more in 2023.
Not all government debt, however, carries these higher interest rates. Just as with typical mortgages, much of the government debt bears the interest rate applied when it was taken on. The difference is, unlike homeowners, the government does not pay off its debt. Instead, it rolls over old debt into new debt – and when it does so, it takes on whatever the interest rate is when the debt is rolled over. Then, in this case, the cost of servicing the overall debt goes up.
The federal government’s interest expense has only begun to reflect the higher interest rates. The average rate the U.S. paid in 2022 was just over 2%, which is up from the 1.61% average in 2021 but still lower than it’s been over much of the past decade. But even so, the effect is being felt. Since the Fed began hiking rates, the U.S. government’s exposure to debt interest has climbed sharply.
It may all sound a little worrying, especially amid talk of a recession. But there are some reassuring economic projections as well. Inflation declined substantially in the second half of 2022. And there is good reason to think that interest rates of 4% – or even less – are in the future, as well as in the Federal Reserve projections.
Either way, the days of borrowing trillions of dollars at near-zero interest rates to finance extravagant spending are over for the foreseeable future.
Gerald P. Dwyer is a professor emeritus of economics and BB&T Scholar at Clemson University. Distributed by The Associated Press.
