Federal Debt Continues to Increase – Are Interest Rates Next?

The latest budget presented by the White House (and with the endorsement of Congress) includes $3 trillion worth of borrowing and spending initiatives. To calm the alarms, government officials point out that the increasing federal debt has yet to slow down the economy. Yet, many independent voices are now speaking out about these debt levels' sustainability and their effects on the economy.

The Debt-to-GDP Ratio and Post-Pandemic Recovery

Following the 2020-2021 Pandemic, the Biden administration began an unprecedented spending spree to help the economy recover from repeated closures and rising unemployment. The entire package amounted to $3 trillion, or approximately 15% of the country's total GDP, and this places the package above that of the 1930s New Deal.

Yet, this is not the only source of government spending, which has progressively increased over the last decade. Once they account for infrastructure bills and discretionary spending, the government is looking at increasing federal debt by over $6 trillion in just one year.

The Current Effects of Government Spending

Surprisingly, the government's spending plan has been met with quiet acceptance, even among free-market economists. Although some parts of the Build Back Better plan remain unapproved, the increase in debt is already four times the costs of the once-controversial 2017 tax cuts.

Opposing figures, such as Republican Lawrence Kudlow and Democrat Jason Furman, have agreed that current debt levels are "manageable." Supporting this view is the overwhelmingly positive turn of the economy over the past six months.

Over the last quarter of 2021, economic growth in the U.S. has continued to accelerate. Job growth has provided workers with an unexpected level of freedom.

Two Reasons Why A Federal Debt Crisis Is In The Works

The influx of cash injected by the Federal Government has infused life into the country's Main Streets. Behind this optimism are fears about the unsustainability of current policies.

According to analyst Brian Riedl, current optimistic projections make two fundamentally wrong assumptions. Combined, they could spell the foundation of a more prominent crisis than the one experienced in 2008.

First reason: ongoing spending will accumulate

An increase of $6 trillion may not appear momentous compared to the overall size of the U.S. economy. However, federal debt is usually contracted in terms of 69 months – and it is easy to lose track of what is set to expire during the next two to five years.

If one looks further back, figures quickly become alarming. There are approximately $17 trillion from before the pandemic that remain unpaid. This will bring the total debt to $44 trillion in less than three years.

Once government debt expires, any unpaid amounts need to be renegotiated. At this point, lenders have an opportunity to switch their interest rates, depending on the current level of risk. The psychological effect of large, unexpected amounts in the "due" column can create an additional problem.

Second problem: Interest rates are not locked – and will likely increase

The government's current calculations assume that effective interest rates will keep the downward trend they have followed since the 1990s. Even Wall Street firms firmly believe that interest rates will remain stable.

But according to Riedl, "current leaders have consistently failed to predict even short-term economic variables for the past half-century."

This should be enough to take any optimistic projection with a grain of salt. Other developing factors should also serve as a call for caution. For the United States, two of the most important ones are the impending cuts to Social Security (necessary to protect it from the large number of Baby Boomers who are about to retire); and a possible de-acceleration of productivity brought about by technology.

Risk Management and Moderation are Needed

High debt levels and sharp hikes in interest rates could be a dangerous combination. Over the past two decades, economists have consistently failed to predict the non-economic dangers that are bound to impact finances. "Black swan events" such as a pandemic or a new international conflict are becoming more frequent and should be acknowledged as a possibility rather than a surprise.

Otherwise, the country may find itself with "no backup plans."

Grassroots Pulse covers public policy and political issues aimed at engaging highly-active policy makers, donors, and grassroots leaders at the forefront of the political process in America today.

Image Credit: Photo by Alexander Schimmeck on Unsplash

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