https://www.washingtonexaminer.com/policy/economy/how-rising-interest-rates-will-affect-federal-spending-and-debt

Interest rates are rising quickly — this is how those rising rates are set to increase federal spending and deficits.

At the start of November, the yield on a 10-year Treasury note was hovering around 1.5%, a record low level. Now, following the Federal Reserve’s efforts to tighten money, the yield on the 10-year Treasurys has leaped to 2.86% — the highest it has been since near the end of 2018.

Here’s what the rising rates mean for the federal government’s finances:

How quickly will rising interest rates translate into higher costs for the Treasury?

The effect of rising interest rates on the federal government’s costs will happen quite quickly, according to data gleaned from the Treasury Department’s quarterly refunding report.

The average maturity on U.S. debt is 73 months. Just under one-third of that debt will mature in the next year, while some 52% of debt will mature within the next three years, according to the department.

That means that the Treasury will soon face having to pay higher interest rates on much of the $23 trillion in debt held by the public.

“There’s short-term debt that is just a couple months that is already going to be rolling over into the higher rates, but I would say the bulk of the higher interest costs will be over the next five years or so,” said Brian Riedl of the Manhattan Institute.

Riedl told the Washington Examiner that the average maturity has fallen because the government during the pandemic started relying more heavily on short-term borrowing because of the lower interest rates. The problem is that when those short-term bonds roll over, the country is subject to whatever the new, higher rates are.

What will higher rates mean for federal spending on interest?

With the yield on the 10-year note at 3%, federal spending on interest would increase to $440 billion next year, $125 billion more than if yields were at 2%, according to a recent Congressional Budget Office analysis. Interest payments would rise to 1.7% of gross domestic product, rather than 1.2%.

The difference, $125 billion, is more than the $104.9 billion spent by the Department of Transportation in fiscal year 2021, showing the importance of interest costs for the federal budget.

What will higher interest rates do to deficits?

The latest budget office projections are for the federal deficit (that is, the amount by which revenues fall short of spending) to total $1.15 trillion for fiscal year 2022. But with the yield on a 10-year Treasury at 3%, that would rise to $1.22 trillion.

Similarly, the deficit would increase by $216 billion in fiscal year 2023 and $297 billion in 2024. As a share of GDP, the deficit would rise to 4.5% by 2025 in a scenario with interest rates a percentage point higher.

Maya MacGuineas, the president of the Committee for a Responsible Federal Budget, described the current situation that the United States is in with rising interest rates as a “precarious time.”

“When your debt is as large as ours is and you’ve spent the past years telling yourself that interest rates will never go up again and so you should just keep borrowing more, the reality that interest rates go down and they go up is going to hit in a very expensive way,” MacGuineas told the Washington Examiner.

Riedl said what the U.S. has done is that it has created a federal budget that is only sustainable if interest rates remain below 3% permanently. He said that the U.S. is “basically gambling” its fiscal future on the hope that interest rates don’t exceed 3%. If interest rates go up to 4% or 5%, the amount of borrowing that the country is scheduled to make is going to be unsustainable.

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While average consumers will experience the effects of rising interest rates in their everyday lives (whether it’s with credit cards, home mortgages, or buying a car), they might also feel some pain because of federal deficits.

“It also matters when the interest payments are going up because that means it’s squeezing out all the room in the federal budget that could be for other things,” MacGuineas said. “So whether you’re the biggest conservative who wants huge tax cuts or the biggest progressive who wants big new spending programs, the first place … that our taxes go to the federal government for is paying interest payments.”

What will it do to debt?

If interest rates stay on their current, higher trajectory, the federal debt will rise to $27.8 trillion by 2025, the CBO found, about $800 billion more than previously projected.

Relative to the size of the economy, though, the debt would actually fall, from 99.6% to 96.4%.

That’s because interest rates are rising because of inflation, which is also increasing nominal GDP — that is, GDP before adjusting for inflation.

“Higher inflation affects not only the amount of debt but also how burdensome that debt is,” CBO Director Phillip Swagel said in a recent presentation.

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