Government Debt and Interest Rates
September 18, 2003
The negative impact of the U.S. government's budget deficits on the economy has been exaggerated, says Ken Judd (Hoover Institution).
Although large budget deficits will tend to raise interest rates, the effect will be much smaller than what some have predicted. Likewise, the U.S. government is a large debtor, but it is borrowing money from a credit market in which it is only one among many other debtors.
According to Judd:
- The value of current federal debt as a percentage of total debt held in the United States is only 12 percent.
- Federal government debt is an even smaller fraction of total debt worldwide.
- The U.S. government's debt equals about one-third of U.S. gross domestic product, which is a low ratio by international standards.
Although it is possible for the Federal Reserve to use inflation to help reduce the value of the government's debt, the Fed has not resorted to "inflationary finance" in the recent past. Consequently, creditors are unlikely to demand higher interest rates to compensate them for expected inflation, says Judd.
Although consistent budget deficits can be economically harmful in the long run, Judd concludes that interest rates in the United States are unlikely to rise very much as a result of the government's deficits.
Source: Ken Judd, "Are Deficits and Interest Rates Related?" Weekly Essays, June 23, 2003, Hoover Institution.
Browse more articles on Economic Issues