Interest on Federal Debt Deserves Scrutiny
April 5, 2011
Unprecedented levels of government spending, mostly in response to the financial crisis, have resulted in the highest level of public indebtedness in the United States since World War II. As the national debt rises, the interest on the federal debt merits increased scrutiny and concern, say Thomas Stratmann, a professor of economics at George Mason University and a scholar with the Mercatus Center, and Gabriel Okolski, an alumnus of the Mercatus Masters Fellowship at George Mason University.
Interest on debt represents a very real cost of federal borrowing.
- Government borrowing to fund persistent deficits is not free -- the Department of the Treasury must pay interest to holders of U.S. debt.
- Ultimately, the cost of this debt is a function of two different factors: the level of government indebtedness and the interest rates on government debt instruments.
Given the large amounts of recent federal spending, spending on interest is likely to increase.
- In its fiscal year 2010 budget, the executive branch estimates that net interest payments will jump to more than 11 percent of the federal budget by 2014.
- A Congressional Budget Office (CBO) estimate finds that net interest costs will double from just below 1.5 percent of gross domestic product (GDP) in 2010 to nearly 3 percent of GDP in 2015.
- If such estimates are realized, net interest on the debt would be higher than any level since World War II.
The consequences of misestimation can be severe. Earlier this decade, the CBO found that if interest rates increased by 1 percentage point over its baseline estimates, interest costs to the federal government would increase by about $11 billion in fiscal year 2004.
Difficulties in predicting the level of future interest payments on the debt may mean that expected expenditures may place additional pressures on economic growth and future private investment, say Stratmann and Okolski.
Source: Thomas Stratmann and Gabriel Okolski, "Interest Payments on the Federal Debt," Mercatus Center, March 2011.
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