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Higher public debt, but a lower cost to service it

The federal government passed the CARES Act in March 2020 to provide support for individuals and businesses affected by the pandemic. The spending associated with it was financed through the issuance of Treasury securities. And, over the course of the second quarter of 2020, the total public debt grew by $3 trillion, or 14%.

Despite this large increase in the public debt, interest payments by the federal government actually declined from $375 billion in 2019 to $345 billion in 2020.

The FRED graph above plots total public debt and federal interest payments as percentages of GDP beginning in 1970. Despite the increase in the debt-to-GDP ratio since 1970, interest payments as a percentage of GDP have not increased in tandem. In fact, from the mid-1980s to mid-1990s, interest payments as a percentage of GDP were nearly twice current levels.

The reason for this discrepancy is simply that the cost of servicing the outstanding stock of Treasury securities has declined. The FRED graph below shows the 10-year constant maturity Treasury yield (in blue), plotted alongside the federal funds rate (in red) and year-over-year CPI inflation (in green). To combat inflation during the mid-1970s and early 1980s, the Federal Reserve increased the federal funds rate, which in turn increased the interest expense of the debt. In early 2020, the Federal Reserve lowered its target for the federal funds rate and purchased substantial quantities of Treasury securities, which had the effect of lowering the interest expense of the debt.

As the Federal Reserve curbs its purchases of Treasury securities and contemplates increases in its policy rate to combat inflationary pressures, the cost of servicing the national debt is likely to rise. The macroeconomic consequences of such a development are difficult to forecast, since they depend on a variety of factors. The political consequences, however, are likely to manifest themselves as heated debates over the need for fiscal austerity measures.

For detailed discussions of the national debt, see Does the National Debt Matter? and How Much Debt Is Too Much?

How these graphs were created: First graph: Search FRED for “federal debt” and select “Federal Debt: Total Public Debt as a Percent of Gross Domestic Product.” From the “Edit Graph” panel, use the “Add Line” tab to search for “federal outlays interest” and select the appropriate series. From the “Format” tab, select “Right” for the y-axis position for Line 2. Second graph: Search for “10 year constant maturity” and select the monthly version of the “Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity” series. From here, as with the first chart, use the “Add Line” tab to search for the remaining series.

Suggested by David Andolfatto and Joel Steinberg.

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