Fed Rate Hikes Will Add Trillions to National Debt

Federal Reserve rate hikes will add trillions to the national debt, according to an analysis by the Committee for a Responsible Federal Budget.

The Fed is expected to deliver another 75-basis point rate hike during its September FOMC meeting. Some speculate the central bank could even raise rates a full 1 percent to fight persistently high inflation. According to the Committee for a Responsible Budget (CFRB), rate hikes will add another $2.1 trillion to the national debt over the next decade.

The debt current stands at $30.9 trillion.

Every increase in interest rate raises the federal government’s interest expense. So far in fiscal 2022, the US Treasury has forked out $471 billion just to fund the government’s interest payments.

To put that number into context, at this point in fiscal 2021 the Treasury’s interest expense stood at $356 billion. That represents a 30%  year-on-year increase. Interest expense ranks as the sixth largest budget expense category, about $250 billion below Medicare. If interest rates remain elevated or continue rising, interest expenses could climb rapidly into the top three federal expenses. (You can read a more in-depth analysis of the national debt HERE.

According to the Congressional Budget Office, this is exactly what will happen. It projects interest payments will triple from nearly $400 billion in fiscal 2022 to $1.2 trillion in 2032. And it’s worse than that. The CBO made this estimate in May. Interest rates are already higher than those used in its analysis.

In a statement to Fox Business, the CFRB concedes that rate hikes are necessary in this inflationary environment. It places the onus on the federal government to get its spending under control.

Policymakers can help the Fed by limiting the need for rate hikes with fiscal policy that pushes inflation in the right direction. That means not enacting legislation and executive orders like student loan forgiveness that have ballooned deficits and only made demand pressures worse.”

Even with pandemic-era spending programs expiring, the federal government continues to spend about half-a-trillion dollars every single month. In August alone, the Biden administration blew through another $523.3 billion. This brought total spending for fiscal 2022 to just over $5.35 trillion.

There is no indication spending will slow anytime soon. While federal outlays have fallen compared to last year as pandemic programs wound down, the US government is still handing out COVID stimulus and it wants more.  Congress recently pushed through another massive spending bill. Meanwhile, the US continues to shower money on Ukraine and other countries around the world. And we haven’t begun to see the impact of student loan forgiveness.

A paper published by the Kansas City Federal Reserve Bank acknowledged that the central bank can’t slay inflation unless the US government gets its spending under control. In a nutshell, the authors argue that the Fed can’t control inflation alone. US government fiscal policy contributes to inflationary pressure and makes it impossible for the Fed to do its job.

Trend inflation is fully controlled by the monetary authority only when public debt can be successfully stabilized by credible future fiscal plans. When the fiscal authority is not perceived as fully responsible for covering the existing fiscal imbalances, the private sector expects that inflation will rise to ensure sustainability of national debt. As a result, a large fiscal imbalance combined with a weakening fiscal credibility may lead trend inflation to drift away from the long-run target chosen by the monetary authority.”

This clearly isn’t in the cards.

“As interest rates rise and the nation’s debt grows, it will become even more expensive to borrow in the future. Congresses and presidents of both parties, over many years, have avoided making hard choices about our budget and failed to put it on a sustainable path. It is vital for lawmakers to take action on the growing debt to ensure a stable economic future,” the Peter Peterson Foundation said.

Interest expense isn’t the only problem the Fed’s inflation fight creates for the US government. Along with raising rates, the Fed is shrinking its balance sheet. That means it’s not buying Treasury bonds. The federal government needs the central bank to continue buying Treasuries in order to prop up the market and enable its borrowing. Without the Fed’s intervention in the bond market, prices will tank, driving interest rates on US debt even higher.

Something has to give. The Fed can’t simultaneously fight inflation and prop up Uncle Sam’s spending spree. Either the government will have to cut spending or the Fed will have to keep creating money out of thin air in order to monetize the debt.

You can decide for yourself which scenario you find more likely.