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How expensive is it to service the national debt?

A battle between interest rates and growth rates

The U.S. federal debt has been rising steadily since the Great Recession and is currently 103 percent of GDP. So let’s enlist FRED to help us study the sustainability of this debt by looking at how much it costs to service it.

Neil Mehrotra recently described the cost of servicing public debt as dependent on the gap between the real interest rate on debt and the growth rate of real GDP: This gap captures the difference between the interest the government must pay to its lenders, in real terms, and the pace at which U.S. income increases. If U.S. income increases more rapidly, then interest payments on U.S. debt shouldn’t be a major burden.

The graph plots this measure of the cost of servicing the debt. (Here, the growth rate of real GDP is the sum of real GPD per capita growth and population growth, and the real interest rate is the difference between the interest rate on a 10-year Treasury bond and the CPI inflation rate.) The graph presents an interesting picture. In the years since the Great Recession, the cost of servicing public debt has been negative, which means that the burden of U.S. public debt is low. Since 1960, negative debt servicing costs have occurred nearly 63 percent of the time; and the average cost of servicing debt is -0.67%. In fact, since the 1960s, the only time period in which the real interest rate was consistently greater than the growth rate of real GDP was from 1981 to 1995.

Interest rates have been low since the previous recession, but they have been on an upward trajectory lately, which may increase the cost of servicing the federal debt.

How this graph was created: Search for and select the series “Constant GDP per capita for the United States.” From the “Edit Graph” panel, set the frequency to “Annual.” Then add three more series in this order to the same line: “Population Growth for the United States,” “10-Year Treasury Constant Maturity Rate,” and “Consumer Price Index for All Urban Consumers” (all at anual frequencies). Set the units for constant GDP per capita to “Percent Change from Year Ago” and the units for CPI inflation to be “Percent Change.” Then, in the Formula bar, enter the formula c-d-a-b.

Suggested by Asha Bharadwaj and Maximiliano Dvorkin.

View on FRED, series used in this post: CPIAUCNS, GS10, NYGDPPCAPKDUSA, SPPOPGROWUSA

The data behind the fear of yield curve inversions

FRED can help us make sense of the recent discussions about an inverted yield curve. But first, some definitions to get us started: The yield curve is the difference (or spread) between the yield on the 10-year Treasury bond and the yield on a shorter-term Treasury bond—for example, the 3-month or the 1-year. The yield curve is flattening if short-term rates are increasing relative to long-term rates, which is what’s been happening lately. The yield curve is inverted if short-term rates exceed long-term rates, making the spread negative. Inverted yield curves have historically been reliable predictors of impending recessions, which is why people are paying so much attention to the yield curve now.

This FRED graph effectively illustrates that every recession since 1957 has been preceded by a yield curve inversion. (Note that the lag between the inversion and a recession varies: With the 10-year and 1-year yields, the lag is between 8 and 19 months, with an average of about 13 months.) A common interpretation is that the yield curve measures investors’ expectations of economic growth in the current period compared with economic growth in the future. According to this interpretation, a yield curve inversion implies that investors expect current economic growth to exceed future economic growth, indicating a recession is likely.

Of course, some question the strength of the relationship between U.S. yield curves and recessions. The graph shows that, in 1965, the yield curve inverted but a recession didn’t closely follow. So, although yield curve inversions are good predictors of recessions, they’re not perfectly correlated and the exact relationship isn’t completely understood.

In December 2013, the spread between long and short rates was very close to 3 percent. In September 2018, the spread was 0.44 percent for the 10-year and 1-year yields and 0.87 percent for the 10-year and 3-month yields. If the yield curve were to continue its downward trend from its previous high in December 2013, the yield curve would invert in August 2019 (using the 10-year and 1-year yields). Historically, this would predict a recession sometime in 2020. As the yield curve flattens, we can expect economists and financial markets will closely monitor its level and make many predictions about whether and when a recession will follow.

How this graph was created: On the FRED homepage under the search box, use the “Browse data by…” option to search under “Category.” From there, select “Interest Rates” under “Money, Banking, & Finance.” Select “Treasury Constant Maturity.” Find and select the monthly “10-Year Treasury Constant Maturity Rate” series. From the “Edit Graph” menu, use the “Customize data” section to search for “1-Year Treasury Constant Maturity Rate” and select the option with “Monthly, Percent, Not Seasonally Adjusted” and add to the graph. The latter series is labeled as series “b.” Under “Customize data,” type a-b into “Formula” box and select “Apply.” Now select “Add Line” and follow this same process using “3-Month Treasury Bill: Secondary Market Rate” as the “b” series.

Suggested by Matthew Famiglietti and Carlos Garriga.

View on FRED, series used in this post: GS1, GS10, TB3MS

Two tales of federal debt

Why people disagree on the level of the federal debt

There’s much disagreement on whether the federal government’s debt is too high. Here are two ways of looking at this perfectly understandable question.

The top graph shows the federal debt as a share of GDP. You want to compute such a share because the federal debt over long horizons depends on the size of the economy. There’s been a marked increase in debt in response to the past recession, and it has leveled off at about 100% of annual GDP. Some consider that high. Some consider that too high.

The bottom graph multiplies the series above by the 10-year Treasury rate. This represents how much the debt costs, as a share of GDP. Here we see the cost is remarkably low—of course, thanks to low interest rates. Note that this is an approximation, as not all debt is in 10-year Treasuries and the issue dates vary greatly in the portfolio. But including other interest rates gives the same general picture. Looking from this angle, some consider the debt to be too low.

How these graphs were created: For the top graph, search for “federal debt” and the series of it as a share of GDP should be among the top choices. For the bottom graph, use the first graph and go to the “Edit Graph” section: Add a series to the first line by searching for “10-year treasury rate” and applying formula a*b/100.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: GFDEGDQ188S, GS10


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