Friday, March 16, 2012

Federal Budget Sensitivity to Interest Rates

Probably because the S&P is at 1400 and oil is over $100 a barrel, CNBC was legitimately discussing the possibility that the Fed may not be able to keep rates at 0 through 2014.  While raising rates would probably be rational in an inflationary environment, below is one reason why the Fed might not be able to raise rates even if they wanted to for the foreseeable future.

The rapid growth in US government debt has made the finances of Uncle Sam extremely sensitive to changes in interest rates.  Below is a rough analysis of what the effect of higher interest rates would be on Federal Government interest expense.

If the average rate paid by the US government hit 4% on $15T in debt, then interest expense would be $620B, more than 20% of receipts. At 6% it becomes the largest expense item, more than 35% of receipts.  Recall that receipts only represent half of what the government spends, so increases in interest expense are pure increases in deficit.

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