The Corner

The Fiscal Trap

Over at the Weekly Standard, Larry Lindsey makes a very important point, pertinent to both the QE2 debate and the conversation in recent weeks about various proposals to reduce the deficit and debt. Most of the baseline assumptions about the size of our debt assume that today’s exceedingly low interest rates continue. If they don’t—even if rates just return to the average of the past 20 years—the picture looks far more grim.

Over the past 20 years, the average interest rate the Treasury has had to pay on money it has borrowed has been 5.7%. But over the past year, the average rate has been 2.2%. That’s no small difference given the size of our debt.

As Lindsey points out, if the current very low rate continues, and our fiscal policy basically follows the track laid out by the president’s last budget, then the interest on the debt 10 years from now will be a little over $350 billion. If the rate goes back to the 20-year average, however, interest on the debt 10 years from now will be more like $1.15 trillion. Again, no small difference. Indeed, it is enough to make some prominent elements of our deficit debate seem a little ridiculous. As Lindsey writes:

The increase in annual interest costs in 2015 alone—$557 billion—is nearly six times the additional revenue that is supposed to be collected by letting the higher end of the Bush tax cuts expire, the centerpiece of the current fiscal policy debate in Washington. The increase in interest costs in 2019—$795 billion—is two-and-a-half times the value of all the Bush income tax cuts of 2001 and 2003 that are due to expire.

Many of the savings in the various deficit-reduction proposals bandied about in recent weeks would also be swamped by the same effect. But of course, wishing for interest rates to remain as low as they are doesn’t make much sense either—these low rates are a function of the economic crisis we have just been through. Better economic growth, which we all want, would surely bring higher interest rates—and the Fed has certainly been pursuing this goal too (whatever you might think of the means by which it has done so).


The solution, of course, is to reduce the size of the deficit and debt while fostering economic growth. So even if the prospect of exploding interest costs makes a mockery of some recent deficit-reduction proposals and projections, deficit reduction is exactly what we need to head off that exploding interest. The particular figures in various projections—whether it’s the numbers offered by the president’s fiscal commission, the figures put out by the Congressional Budget Office, or the projections soon to come in the administration’s budget—are likely to be pretty far off mark. But the point is the basic direction of our fiscal policy. We simply must begin to move toward lower spending and higher growth. As Lindsey makes clear, time is genuinely running out if we are to avoid a Japanese-style calamity.

Yuval Levin is the director of social, cultural, and constitutional studies at the American Enterprise Institute and the editor of National Affairs.


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