May 8, 2024
The Federal Reserve has kept the federal funds rate, the interest rate at which commercial banks can borrow and lend overnight, unchanged since July 26, 2023. The federal funds rate is used by the Federal Reserve to keep inflation in check, but the rate also influences the federal government's borrowing costs and, therefore, the nation's fiscal position.
The federal funds rate is a benchmark for Treasury bills and other short-term securities. Adjustments to interest rates are an important tool by which the Federal Reserve accomplishes its statutory mission: to promote the goals of maximum employment, stable price levels, and moderate long-term interest rates. Expectations about short-term interest rates, along with other factors, can also affect longer-term interest rates that apply to business investment loans and consumer borrowings such as mortgages and auto loans.
The central bank raised the federal funds rate, which it had kept near zero since the start of the pandemic, seven times in 2022 to tame rising inflation. The Fed continued to raise rates four more times in 2023, setting its interest rate target at a 22-year high of 5.25% to 5.50%. The central bank has kept rates there since then. Meanwhile, interest rates on short-term Treasury bills have been rising at a similar pace. The rate on the three-month Treasury note rose from 0.15% at the start of 2022 to 5.24% in April 2024.
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When interest rates on U.S. Treasury bonds rise, so do federal borrowing costs. Historically low interest rates allowed the U.S. to borrow cheaply to respond to the pandemic. But when the Federal Reserve raised the federal funds rate, short-term interest rates on Treasury bonds also rose, partially raising the federal government's borrowing costs. Long-term interest rates were already rising as well, driven by short-term interest rates and expectations of inflation.
The Congressional Budget Office (CBO) projected in February that annual net interest costs would reach $870 billion in 2024, nearly doubling over the next decade. That means they would jump from $951 billion in 2025 to $1.6 trillion in 2034, for a total of $12.4 trillion over that period. But if inflation is higher than the CBO projects and the Fed keeps interest rates on hold for longer than the agency predicts, those costs could rise even faster than expected.
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Rising interest costs also pose a major challenge in the long term: CBO projects that interest payments will total about $77 trillion over the next 30 years, accounting for 34 percent of total federal revenues by 2054. Interest costs will also be the largest “program” in the U.S. for decades to come, surpassing defense spending in 2024 and Social Security spending in 2051.
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Rising interest costs threaten to crowd out important public investments that could fuel future economic growth: CBO projects that by 2054, interest costs will be nearly three times what the federal government has ever spent on R&D, nondefense infrastructure, and education combined.
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The long-term fiscal challenges facing the United States are serious. While significant borrowing was necessary to respond to the COVID-19 pandemic, structural imbalances between spending and revenues that existed before the pandemic remain large and will grow rapidly in the future. Moreover, rising interest rates and a growing national debt will make borrowing costs even more expensive in the future. For years, Congress and presidents of both parties have avoided tough budget choices and failed to put the budget on a sustainable trajectory. To ensure a stable economic future, it is essential that lawmakers take action on our growing debt.