U.S. debt swelled, reaching roughly 100 percent of the size of the overall economy in 2020. This happened seemingly without consequence to anyone — not the federal government, not markets, not the overall U.S. economy and definitely not normal consumers, for whom this whole fiscal debate probably looks like an abstract morality play. Despite mounting debt, the world was still willing to lend to the U.S. government on the cheap. Which meant U.S. consumers and businesses could borrow on the cheap, too.
But something shifted this summer: The government’s long-term borrowing costs started climbing. The interest rate on the 10-year Treasury touched 4.8 percent earlier this week, up from 3.3 percent six months earlier. Those long-term rates are now hovering around 16-year highs and are generally much higher than budget watchers had been forecasting.
This means that however ugly the fiscal forecasts looked before, they could still be too optimistic.
Exactly why long-term rates have risen so much so fast is unclear. The answer doesn’t seem related to inflation (or the Federal Reserve’s inflation response, which focuses on short-term interest rates), since long-term inflation expectations have stayed quite stable. Rather, economists have suggested it’s likely due to a combination of other things. These include U.S. budget deficits, the Fed shrinking its balance sheet (which means selling off longer-term Treasury securities), yet another rating agency’s downgrade of U.S. sovereign debt (plus a signal that the one rating agency holding out on a downgrade might join in, too), political dysfunction, and assorted international factors.
Whatever the cause, if this keeps up, things could get very hairy in the next few years.
When long-term rates rise, all the debt that the government has already acquired becomes more expensive to maintain. The same is true for any new debt Congress plans to add. There are a lot of dollars in that latter category, since politicians have made commitments to continue spending more than the government collects in taxes.
Unless we get a sudden boom in economic growth, higher interest rates mean that the cost of servicing our debt will expand and crowd out our ability to spend on other things we care about.
For a very long time, politicians haven’t had to make tough choices about which spending programs to cut or which taxes to raise, because borrowing to fill a budget hole was effectively free. They lived in a world without trade-offs.
Going forward, borrowing might not be so free.
If interest costs rise and economic growth doesn’t keep up, we’ll have much less “fiscal space” to commit to new programs — even ones that might offer a huge return on investment (such as resources that help kids from low-income families become more productive, taxpaying adults) or that are needed to respond to an unexpected shock (recession, pandemic, war). If borrowing costs stay higher than economic growth, that also stresses our ability to pay for critical programs we have today.
There’s an obvious solution for all this: The government could start making more responsible budget decisions by raising revenue and/or curbing spending. Or, for that matter, by bringing in more working-age immigrants to increase the productive capacity of the economy as the country ages.
Obvious — and yet all seemingly impossible.
Lawmakers have lately struggled to make even routine fiscal decisions, such as paying our bills on time (even while we still can afford them) or passing regular spending bills to keep the government running. It is hard to imagine lawmakers making proactive policy changes to reduce deficits, especially since all of the required changes would be unpopular with some core constituency.
The problem isn’t merely the general political dysfunction that infects other parts of governance. That long period of free money, when politicians never faced tough trade-offs, made the parties especially inept on fiscal issues.
Politicians got lazy and complacent, happy to proffer pretty much any goody to win votes, whatever the hit to the budget. Once upon a time, the main obstacle to reducing deficits had been that the political parties each promised different but expensive things, which could theoretically be paid for from the other side of the ledger: The Republican Party wanted low taxes, while the Democratic Party wanted bigger spending.
Today, both parties promise both. That is, President Biden is on board with extending the Trump tax cuts for 97 percent of households; Republicans have happily expanded spending and pledged to leave programs such as Medicare untouched.
Someday soon — perhaps sooner than anyone would like — someone will have to break a promise.
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