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Rate Hikes May Add $1T to Interest on National Debt

It’s not just higher mortgage payments: Increases to the target range for the federal funds rate by the Federal Open Market Committee (FOMC) could mean the U.S. will pay as much as $1 trillion more this decade on interest payments for the national debt, according to the Peter G. Peterson Foundation.

With inflation at its highest rate in decades, the U.S. Federal Reserve has repeatedly increased benchmark interest rates in recent months. As of October 2022, the federal funds rate ranged from 3% to 3.25%, compared with close to 0% early in the COVID-19 pandemic. While the rate is already the highest since 2008, analysts expect the Fed to keep pushing it up this year.

Key Takeaways

  • The U.S. Federal Reserve has increased the federal funds rate to between 3% and 3.25% through a series of hikes in recent months.
  • Higher national interest rates could mean higher interest payments by the U.S. government on the national debt.
  • Deficit advocacy organization the Peter G. Peterson Foundation has estimated that Fed interest rate hikes could lead to $1 trillion in added interest rate payments in the years to come.

Higher Rates Could Mean More Costly Debt

The U.S. has borrowed heavily in recent years to address the pandemic and to facilitate major tax cuts. Now, as the Fed moves to combat inflation, the interest the government owes on public debt could jump. Since borrowing costs for the U.S. government rise and fall along with interest rates, an increase in the federal funds rate to a predicted 4.6% by the end of 2023 could drastically increase the cost of debt.

The Congressional Budget Office (CBO) has forecast that President Biden’s 2023 budget would lead to federal deficits over the 2023-2032 period of $13.1 trillion, compared with a previous estimate of $8.1 trillion. Even small changes to national interest rates can lead to significant changes in public debt interest payments: If rates rise to a single percentage point above the CBO’s estimates for the next several years, it could mean that the U.S. will spend more on interest payments than national defense by 2029.

Complicated Picture of Inflation, Recession Concerns, and Economic Growth

Recent months have been particularly volatile for the U.S. economy, as investors alternate between concern about a significant recession and optimism about future growth. A recent government report suggesting job growth is slowing may have bolstered investor confidence that the Fed could slow its pace of rate increases.

At the same time, the CBO and the Biden administration have recently shown confidence in the overall growth, forecasting that national debt as a portion of the size of the broader economy will decline over the next year. That happens when the economy grows faster than the national debt.

President Biden has said that achieving cuts to the national deficit is a top fiscal priority. Yet the non-partisan Committee for a Responsible Federal Budget estimates that his administration has added $4.8 trillion to the deficit tsince taking office last year. By early October, the U.S. national debt exceeded $31 trillion for the first timer.

All told, an increasing debt load and higher interest payments could lead to a global loss in confidence in the nation’s ability to repay its debts, which in turn could further exacerbate inflation, interest rate increases, and other economic concerns.

What Is Happening With the National Debt?

In early October, the U.S. national debt climbed above $31 trillion for the first time. As the Fed increases interest rates, the U.S. government will likely have to pay a substantial amount more in interest payments in the coming years.

What Will Happen if the National Debt Keeps Rising?

The higher the national debt, the more likely it is that investors could consider the U.S. a global credit risk and unable to repay what it owes.

What Is the Impact of the Federal Funds Rate on National Debt?

The higher the federal funds rate, the more the U.S. government may have to spend in interest payments on the public debt. By some estimates, Federal Reserve interest rate hikes that have taken place in recent months could contribute to up to $1 trillion in additional interest payments.

The Bottom Line

The U.S. Federal Reserve has instituted a series of interest rate hikes in an effort to combat the worst inflation seen in decades. At the same time, heavy government borrowing has continued to grow the U.S. national debt. In combination, higher interest rates could obligate the government to significantly increase the amount it pays in interest payments on the national debt in the years to come.

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