The Federal Reserve’s inflation-fighting measures are fueling a rise in the national debt as the central bank prepares to keep interest rates high for a long time.
Inflation has fallen sharply since the Fed raised interest rates to their highest level in 20 years last year, but officials remain concerned about how quickly prices are rising. Fed officials plan to cut interest rates one more time by the end of the year, taking the benchmark borrowing rate from 5% to 5.25%.
Higher Federal Reserve interest rates force the federal government to borrow money at a higher cost, and with government spending expected to rise over the next decade, the amount the country will pay in interest on trillions of dollars of debt is on track to exceed defense spending.
“It’s not the only factor, but it is contributing to the deficit,” Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics, said in an interview.
“But strangely, large budget deficits themselves support large spending, which in turn forces the Fed to keep interest rates high,” he continued.
According to recent figures from the Congressional Budget Office (CBO), the national debt, currently more than $27 trillion, is projected to skyrocket over the next decade relative to the size of the country’s economy, rising from 99% of gross domestic product (GDP) in fiscal year 2024 to 122% a decade later.
Experts say most of the projected increase is due to spending, but some point out that the Fed’s inflation-fighting measures are also contributing to the increase.
“The government is spending a lot, but they’re not collecting taxes from the people, so they’re still spending and it’s too much for the economy,” Gagnon said.
The Fed raised interest rates for the first time in 2022 after setting them near zero to buoy the economy during the coronavirus pandemic, when the government passed a hefty COVID-19 relief package and boosted government spending.
The purpose of raising interest rates is to reduce demand by discouraging consumers from borrowing, and while borrowing can become more costly for the government as well, experts say that doesn’t mean it will respond in the same way as consumers.
“It’s a little different than trying to buy a car and saying, ’10 percent interest rate is too high, I can’t afford this new car,'” Gagnon said.
“If Congress passes a law that says this much spending is required and tax rates are x, then initially it doesn’t respond to interest rates,” he said. “But if interest rates increase the deficit over time and Congress says, ‘Hold on a second, this deficit is too high,’ then it may reduce the deficit.”
CBO projects interest payments will reach $892 billion in 2024, exceeding annual defense spending, and eventually reach $1.7 trillion in 2034, “at which point interest payments will roughly equal projected Medicare spending,” the report said.
But at the same time, the agency noted in its forecast that it expects the Fed to cut interest rates in 2025, which some have noted will underscore government spending.
“The interest cost of debt is the product of the interest rate and the amount of government borrowing,” David Wessel, a senior economist at the Brookings Institution, said in an interview. “And the bigger factor is the amount of government borrowing, which is really why interest as a percentage of GDP is rising.”
“Obviously, when the Fed raises interest rates, particularly short-term rates, the bond market pushes up longer-term interest rates, which makes borrowing more expensive. That’s true,” he said. But, he added, “it’s not the Fed’s actions that are the big driver.”
Another factor federal analysts cite behind the projected rise in the national debt is rising mandatory spending, particularly for Social Security and Medicare. The CBO projects that spending on mandatory programs will “rise as a share of GDP from 14.7 percent in 2024 to 15.3 percent in 2034.”
“Two fundamental trends are contributing to this increase: the rising average age of the population (known as population aging) and rising federal health care costs per beneficiary,” CBO said.
Fiscal hawks and experts say the forecast is a warning to Washington, as the two sides remain deeply divided over how to tackle the nation’s budget deficit.
“I think this is very dangerous. The fact that the interest costs on the debt, as a percentage of GDP, have barely risen in about 40 years, I think gives Congress an excuse not to address the debt problem,” said Eugene Stuele, Richard B. Fisher President and fellow at the Urban Institute, adding that “the interest costs clearly put a lot of pressure on Congress to address the debt problem.”
Lawmakers in both parties are already looking ahead to 2025, the year Congress will again face a fierce battle over the national debt borrowing limit, which caps how much the Treasury can borrow to cover the nation’s bills.
The last time Congress suspended the debt ceiling was in 2023, after months of bitter partisan fighting over spending. The national debt was about $31 trillion at the time and has since grown to more than $34 trillion.
“Eventually, Congress will take some kind of action. Maybe it’s because there’s some kind of crisis going on, maybe it’s because leadership is emerging, maybe it’s because the Social Security and Medicare trust funds are running low,” Wessel said.
