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The cost of owing : How rising interest rates can affect the federal government’s debt payments

Summary:
[embedded content] Rising interest rates mean higher interest rates on debt payments, which means it becomes more expensive to buy a home, buy a car, or even go to college. It also becomes more expensive for the federal government to finance its debt. As interest rates rise, payments on federal government debt also increase. The FRED graph above shows federal government expenditures with interest payments since January 1990: As federal debt has risen, expenditures on interest payments have also risen. These expenditures also depend on interest rate movements: When interest rates fall, payments decrease for the same level of federal debt. The Federal Reserve tends to lower interest rates during recessions, and this translates to lower payments, as seen in 2001 and 2008. (The gray

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Rising interest rates mean higher interest rates on debt payments, which means it becomes more expensive to buy a home, buy a car, or even go to college. It also becomes more expensive for the federal government to finance its debt.

As interest rates rise, payments on federal government debt also increase. The FRED graph above shows federal government expenditures with interest payments since January 1990: As federal debt has risen, expenditures on interest payments have also risen. These expenditures also depend on interest rate movements: When interest rates fall, payments decrease for the same level of federal debt. The Federal Reserve tends to lower interest rates during recessions, and this translates to lower payments, as seen in 2001 and 2008. (The gray shaded bars represent recession periods.)

Conversely, when economic conditions improve, the Federal Reserve tends to raise interest rates and this leads to higher interest payments. The second graph illustrates these two forces behind the movements in federal interest payments: The blue line is the secondary market rate on the 3-month Treasury bill, a measure of the federal government cost of borrowing that tracks very closely the interest rate set by the Federal Reserve (the federal funds rate). The red line is a measure of total public debt.

In principle, these two series can help us disentangle the main driving forces behind increasing interest payments. But doing this is more complicated than it sounds: The reason is that the federal government issues debt at different maturities, and the Fed typically sets only short-term rates. The behavior of interest rates at longer maturities depends on market forces and expectations of future inflation, among other factors.

How these graphs were created: For the first graph, search for and select “federal government expenditures: interest payments”; set the starting date to 1990-01-01. For the second graph, search for and select “3-month treasury bill: secondary market rate” (the monthly series); set the starting date to 1990-01-01. From the “Edit Graph” menu, select “Add Line.” Search for “federal debt: total public debt” and click on “Add data series.” From the “Edit Lines” tab, under “Units,” select “Index (Scale value 100 for chosen date)” and set that date to 1990-01-01. Then, under “Customize data” in the “Formula” field, type “a/100” and click “Apply.”

Suggested by Miguel Faria-e-Castro.

About FRED Blog
FRED Blog
The Federal Reserve Bank of St. Louis is the center of the Eighth District of the Federal Reserve System. This District includes Arkansas, eastern Missouri, southern Illinois and Indiana, western Kentucky and Tennessee, and northern Mississippi.

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