Even With Lower Interest Rates, Debt Remains Unsustainable

With the Federal Reserve today announcing a 0.25 percentage point decrease in the federal funds rate, it appears interest rates will remain lower than projected in the Congressional Budget Office's (CBO) baseline, which will lead to lower future interest spending.  However even with low rates, debt remains unsustainable and major changes to tax or spending policies are still necessary before debt would stop growing as a share of Gross Domestic Product (GDP). 

Below is a slight adaptation of our previous blog: “CBO: Debt Remains Unsustainable With r < g.”

Under current law, CBO projects debt will rise from 78 percent of GDP this year to 92 percent by 2029 and continuously grow thereafter. But even if interest rates remain at their early 2019 levels – rather than rising as CBO projects – debt will still rise faster than the economy, reaching 86 percent of GDP by 2029. In fact, according to CBO, even "if the interest rate on federal debt fell by one half of one percentage point and remained at that low rate over the next decade [we would still face] rising debt as a share of GDP."

So what would it take to stabilize the debt with low interest rates? Under current law, CBO estimates stabilizing the debt would require reducing primary deficits from 1.7 percent of GDP on average to 0.4 percent of GDP, the equivalent of $3.4 trillion in spending cuts or tax increases. 

If interest rates stay at the low levels experienced in early 2019, primary deficits would still need to be cut from 1.7 percent of GDP to 1.0 percent, the equivalent of $1.8 trillion in spending cuts or tax increases over the next ten years. Putting debt on a clear downward path under this scenario would require reducing primary deficits to about 0.5 percent of GDP, the equivalent of $3.1 trillion of spending cuts or tax increases.

Importantly, these projections are based on current law and don't account for the cost of extending recent spending increases or tax cuts. Under CBO's Alternative Fiscal Scenario (AFS), we estimate it would require about $6.9 trillion in spending cuts or tax increases to stabilize the debt at current levels and $5.3 trillion if interest rates remained at early 2019 levels. 

Furthermore, with low interest rates but relatively high debt, the budget is increasingly sensitive to interest rate risk – just a 1 percentage point increase in projected interest rates would cost $1.9 trillion and raise projected debt from 92 percent of GDP in 2029 to 98 percent of GDP.

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Low interest rates alone will not restore fiscal sustainability. Lawmakers need to enact significant deficit reduction to place debt on a downward trajectory.