Feb 1, 2018

After a lengthy period of holding the federal funds rate close to zero in an effort to help the economy recover from the financial crisis, the Federal Reserve began increasing its target for the federal funds rate in December 2015. There have been four subsequent increases since then; the most recent was in December 2017 and set a target rate between 1.25 and 1.5 percent.

The Federal Reserve sets policies to foster conditions that they believe to be consistent with achieving maximum employment, stable prices, and moderate long-term interest rates. Setting the target for the federal funds rate — the interest rate at which commercial banks lend to each other overnight — is therefore an important tool for the bank. That rate is a benchmark for Treasury bills and other short-term interest rates. Expectations about those short-term rates, combined with other factors, affect longer-term rates that are applied to consumer borrowing such as for mortgages or car loans.

The continued tightening of monetary policy should be viewed as a positive sign of economic strength — it demonstrates the bank’s confidence in the progress the country has made toward its economic objectives. However, higher short- and long-term Treasury rates mean that the federal government’s borrowing costs will also rise, thereby generating significant consequences for the budget and the national debt.

Under current law, CBO projects that net interest costs will triple over the next 10 years, soaring from $269 billion in 2017 to $818 billion in 2027 and totaling $5.6 trillion over the period. 1

Interest costs are expected to continue climbing beyond the next 10 years and are projected to be the third largest category in the federal budget by 2026 (after just Social Security and Medicare), the second largest category in 2046, and the single largest category before 2050.

Ballooning interest costs threaten to crowd out important public investments that can fuel economic growth in the future. In its most recent long-term budget report, CBO projects that by 2047, interest costs could be more than double what the federal government has historically spent on R&D, nondefense infrastructure, and education, combined.

The long-term fiscal challenges facing the United States are serious. Deficits are on the upswing again and therefore will be adding significantly to national debt. To be clear, the culprit is failed fiscal policy, not the monetary policy conducted by the Federal Reserve. Over many years, Congresses and Presidents of both parties have avoided making hard choices about our budget and failed to put it on a long-run, sustainable path. In fact, the tax legislation that was just enacted makes it even more difficult to achieve that sustainable path. However, as interest costs rise and with the deficit slated to reach $1 trillion as early as next year, it is vital for lawmakers to take action on the growing debt to ensure a stable economic future.

1 Under current law, CBO projects that interest rates on 3-month Treasury Bills will increase from 0.9 percent in 2017 to 2.8 percent in 2027, while interest rates on 10-year Treasury Notes will increase from 2.4 percent in 2017 to 3.7 percent in 2027. The interest rates are expressed as calendar-year averages. ( Back to citation)

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