Higher borrowing costs due to the Fed's fight against inflation widened the deficit and sparked a bipartisan debt ceiling conflict.
The US Treasury Department said interest payments on public debt were $261 billion in the first four months of the current fiscal year, up 33 percent from $196 billion in the same period last year.
Paying more interest is one of the biggest increases in US government spending so far this year, contributing to the deficit widening to $460 billion, up 78% from $259 billion in the first four months of the fiscal year. immediately before.
Costs increased due to the US Federal Reserve's (Fed) war against inflation over the past time, with the plan to cool down the economy by raising the basic interest rate, which has been close to zero for nearly two years in the past two years. epidemic.
In its projections last year, the US Congressional Budget Office (CBO) said interest payments on the country's public debt as a percentage of GDP would nearly double, from 1.6 percent in 2022 to three .3% in 2032, assuming that the Fed will raise rates to 1.9% by the end of last year and to 2.6% by the end of the year.
However, the Fed raised interest rates much faster than the CBO expected, pushing the base rate to between 4.5% and 4.75% at its most recent meeting, equal to 2007 levels. pushed Treasury yields higher, at around 3.6% on 10-year notes this week, up from about 2% a year ago.
Rising yields seep into interest payments as debt matures. The average yield on US bonds was 2.46% in January, up 0.9 percentage points year-on-year in 2022, according to a senior Treasury official. This contributed to the deficit. $39 billion in January this year, while the same period last year had a surplus of $119 billion.
Republicans and some economists wary of rising debt levels say rising borrowing costs are evidence of the need to cut government spending and narrow the deficit. House Speaker Kevin McCarthy this week said interest rates are unsustainable.
Meanwhile, Democrats and other economists view borrowing costs as still manageable given the size of the economy and spending cuts unnecessary. They largely support raising taxes as a way to reduce the deficit, an approach that most Republicans reject.
"It's true that interest rates have gone up, and gradually increased the cost to the nation and the federal budget in interest. So that's been a drag. But our budget projections have long been false. that interest rates will return to a more normal level," Treasury Secretary Janet Yellen said this week.
The debate over borrowing costs took place as the US Congress stalemate over raising the public debt ceiling to about $31.4 trillion. Republicans, which recently took control of the House, are asking Congress to pass it only if it comes with spending cuts. Mr. McCarthy has said that congress should work towards a balance between spending and income over time.
But coming up with a plan to balance the budget will be challenging, especially as many lawmakers are unwilling to agree to budget cuts for the military, social security and health care. Higher borrowing costs only add to the challenge by increasing government spending.
Meanwhile, Democrats are calling for an increase in the debt ceiling without reducing spending. Yellen has said that the Treasury Department may not be able to pay off all of its debt as recently as June if parliament doesn't raise the ceiling.
According to the Wall Street Journal, economists agree that interest payments could pose a problem if it begins to take up a large portion of the national budget, competing with spending on federal programs and creating a vicious cycle of borrowing more. High debt payments could also start to crowd out private investment, which could hurt growth. But they differ on which part of the spending is the most pressing issue.
"All we really know is that lower interest is of course better," Wendy Edelberg, senior fellow at the Brookings Institution, said of public debt payments. A former chief economist at the CBO, Ms Edelberg said there is currently "no emergency" to compel action.
Michael Faulkender, a Treasury Department official under the Trump administration, said it was impossible to comment on how much borrowing was too much. "Finding out where the limit is is a disaster because it means we've had a failure in the bond market," he said.
A central question in determining how challenging the public debt problem is is whether inflation is temporary or long-term pressure in the economy. Answering the question will help determine the future trajectory of interest rates and borrowing costs.
During the 1990s, US policymakers curbed the budget deficit to make US Treasury bonds more attractive to buyers. For most of the past 20-year period, low inflation and high global demand for U.S. Treasuries have kept borrowing costs down, even as other spending drives debt and deficits. higher.
According to CBO estimates, inflation is expected to fall to 2% by the end of 2024, with the Fed's benchmark interest rate averaging 2.5% over the next decade. Michael Strain, director of economic policy research at the American Enterprise Institute, said policymakers will need to address the debt regardless of future interest rate movements.
"If interest rates go high, that's going to be a problem. If interest rates go back to pre-pandemic levels, that's still going to be a problem. A less pressing issue, but nonetheless a problem. a problem," he said.