What happens when you borrow a lot of money, and then interest rates go up? Your interest payments can take a big jump, too. That seems to be happening with interest payments on the national debt. All numbers and projections that follow are from the Historical Tables volume of the proposed FY 2024 US budget produced by the US Office of Management and Budget. This volume provides actual overview data on government spending and taxes up through 2022, and the provides estimates from 2023-2028.
As an example, a previous time that the US government borrowed large amounts at a time of high interest rates was the 1980s. As a result, net interest payments by the federal government doubled from 1.5% of GDP in 1977 to 3.0% of GDP by 1985. In very round numbers, federal spending has been around 20% of GDP for some decades now. Thus, 3% of GDP is about 15% of the total federal budget.
We are now repeating that experience. Net interest payments had fallen as low as 1.3% of GDP in 2009, when the Federal Reserve chopped its policy interest rat (the “federal funds” rate) to near-zero. Interest payments were 1.3% of GDP in 2016 and 1.6% of GDP in 2021. But federal borrowing was high and interest rates started rising. Interest payments are supposed to hit 2.9% of GDP of GDP by 2024, and 3% of GDP a few years later.
Just in case you are the kind of person who doesn’t think in terms of percentages of GDP, interest payments are essentially going to double from $299 billion in 2021 to $583 billion in 2024.
Let’s put 3% of GDP in the perspective of other federal taxes and spending. A few years from now, 3% of GDP will be net federal interest payments. It will also be more-or-less equal to the sum of all federal corporate income taxes (2.5% of GDP) and all federal excise taxes (like those on gasoline, alcohol, and tobacco). In other words, all the money raised by those taxes will effectively be going out the door to pay interest on past borrowing. Or to look at it another way, 3% of GDP is projected national defense spending for FY 2028; by then, spending on interest payments to cover past federal borrowing will equal national defense spending.
I’m a believer in the standard wisdom that when confronted by the Great Recession of 2008-9 or by the pandemic recession of 2021, it makes sense for the federal government to borrow more. It cushions the immediate blow, and helps the economy recover.
But another part of the standard wisdom, not so easily followed, is that when not facing a recessionary threat, the government should scale back on its borrowing–not to balance the budget, but to get on a trajectory where the debt is growing more slowly than the growth of the economy, and thus the debt/GDP ratio is falling. In addition, the government needs to be aware of the risks that rising interest rates will drive up borrowing costs. Future budget decisions will be constrained as a result.
Back in 1693, in his comedy “The Old Bachelor,” William Congreve coined the line: “Married in haste, we may repent in leisure.” As we face a future of much higher interest payments, we will have leisure to repent some of the earlier federal borrowing, as well.