The CBO’s May 2022 model forecasts that debt held by the public will increase to 110% of GDP by 2032, a record amount that would be more than 2x the 50-year average of 46%. Notably, this model assumes a relatively modest increase in interest rates – perhaps an assumption the CBO should have first run by the Fed!
As discussed in our previous post, aging demographics are forecasted to drive unmanageable deficit spending over the next 10 years such that the federal government is projected to borrow another $17 trillion from 2022 through 2032, boosting debt held by the public to $40 trillion, or 110% of GDP. That amount of debt relative to the size of the economy would be the greatest in the nation’s history and would be more than double the 50-year average of 46%.
Notably, the CBO’s 5/22 forecast assumes an average interest rate on debt held by the public of between 2% to 3% for the next 10 years which could prove to be far too modest in relation to the Fed’s recent actions and comments.
In any case, the CBO notes the following risks from higher interest rates:
- Not only will higher rates stress the U.S.’ fiscal position, but they would also increase borrowing costs for the private sector, resulting in lower business investment & slower economic output growth.
- The likelihood of a fiscal crisis in the U.S. would increase. Specifically, the risk would rise of investors’ losing confidence in the U.S. government’s ability to service and repay its debt, causing interest rates to increase abruptly and inflation to spiral upward, or other disruptions.
- The likelihood of less abrupt, but still significant, adverse effects – such as expectations of higher rates of inflation, an erosion of confidence in the U.S. dollar as an international reserve currency, and more difficulty in financing public and private activity in international markets would increase.
- Policymakers might feel constrained from implementing deficit-financed fiscal policy to respond to unforeseen events or for other purposes, such as to promote economic activity or strengthen national defense.