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National Debt’s Effect on the Fed’s Decision to Raise Interest Rates

The Fed has continued to insist that they will begin raising interest rates in the near future, as early as this spring. However, 30-year fixed mortgage rates currently are at a six month low and seem to be headed lower. The fact that lenders are willing to lock in rates this low makes it seem like mortgage lenders and other players in the market do not think that the Fed will follow through in their pledge to raise interest rates.

Since the last time that the Fed decided to tighten its monetary policy (2004), the U.S. federal debt has more than doubled, from $7.8 trillion to an approximate $18 trillion. This is likely the reason behind why the market is skeptical of the Fed’s publicly declared intention to raise interest rates, despite recent trends in the Fed’s truthful transparency. The federal government, in 2014, paid $431 billion in interest expenses on debt. If interest rates rose to historical averages, this expense could be larger than $900 billion. (Just imagine the political implications if this occurred).

While the Fed is independent of the federal government, it has not exactly helped the out-of-control government spending. Through quantitative easing (QE), the Fed is buying trillions of dollars in government bonds, but the interest paid on these transactions is returned to the Treasury as profit at the end of the year. In other words, the Fed is helping the government by allowing them to borrow (hundreds of) billions of dollars interest free which benefits the yearly deficit and debt.

In conclusion, it is unlikely to see interest rates rise very significantly, much less, anywhere close to historical averages due to the large effect that the increased rates would play on the national debt going forward.



  1. HeeJu HeeJu

    I agree that raising interest rates will discourage moral hazard of the U.S government. Another relevant question that we should ask would be “what is an appropriately high level of interest rate that FED should aim for?”. As Mark mentions in his post, the U.S government is already struggling with crippling debts. Though it is a separate entity, FED cannot risk the government officially becoming ‘bankrupt’ (also think about what that can do to the country’s international reputation).

  2. One major factor needs to be added: those 30 year bonds. What the Fed best controls is overnight money; it can only hope to influence 30 year rates. But … all those 30 year bonds don’t come due for 30 years, and in the interim the amount of interest that needs to be paid remains fixed, irregardless of what happens to interest rates.

    It’s also unclear that higher interest rates would have any direct effect on Congress. Yes, the interest burden matters. With debt (illustrative!) of 90% of GDP, an increase in interest rates of 100 bp (basis points = 1/100th of a percentage point) adds 0.9% of GDP to the interest burden — eventually. However, tax receipts are a function of nominal GDP growth, so if the Fed raises nominal rates because nominal growth picks up, the real interest burden need not rise even in the long run.

    We’ll go through both the yield curve and how to model debt dynamics in the next couple weeks.

  3. moores15 moores15

    I came back to this post because of Yellen’s recent statements to Congress earlier this week. While the Fed has yet to raise interest rates, Yellen suggested that a raise in interest rates might occur soon. A number of analysts are convinced this will occur by the end of the year, and some even suggest it could happen as early as June. While the Fed repeatedly emphasized ‘patience’ in December, the use of this word recently has been relaxed maybe further suggesting a rise in interest rates soon. Reporters do have a tendency to place incredible emphasis on certain phrases and words released by the Fed, so maybe journalists are just reading too deep into certain words.

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