Anyone who follows the DC budget game knows that the Congressional Budget Office (CBO) serves as its referee; any proposal that involves new spending or revenue is scored by the CBO for its impact on the federal debt over the next 10 years. That score normally sets the terms on which the proposal will be debated and voted on. So established is this ritual that most spending proposals are described in terms of the CBO’s 10-year scoring window from their conception.
The CBO not only assesses individual bills, but it also produces a baseline for regular forecasts of major economic variables and the path of the debt under current policy. In a sense, these forecasts are the playing field on which budget proposals compete. So, it ought to be a big deal when the CBO changes the shape of the field.
In their most recent 10-year budget and economic forecast, the CBO made a big change, reducing their long-run forecast of the interest rate on government bonds by almost a full percentage point, from 3.7 to 2.9. (See Table 2.6 here.)
As far as I can tell, the new forecast has received very little attention since it was released in August, but this development warrants a lot. Most directly, the new, lower interest rate reduces expected debt payments over the next decade by $2.2 trillion. It also significantly reduces the expected debt-GDP ratio. Under the assumptions that the CBO was using at the start of this year, the debt ratio under existing policy would reach 120 percent by 2040. Using the new interest rate assumption, it reaches only 106 percent. With one change of assumptions, a third of the long-run rise in the federal debt just disappeared.
Debt-GDP Rate under CBO’s Interest Rate Forecasts of January vs. August 2019
At the very least, this means that anyone arguing that federal debt is a climate-change-level threat to humanity needs to update their talking points. The claim that federal debt “will be close to 150 percent of GDP by 2050” is, as of August, not even close to correct. With the new interest assumptions, the figure is less than 120 percent.
To be fair, any argument that doesn’t go beyond the fear of more public spending isn’t likely to be much affected by this revision. But the new interest estimate has broader implications.
If the term “fiscal space” means anything, lower expected interest rates have to mean that there is more of it. The $2 trillion in interest savings that the CBO’s August estimate just handed us could presumably be used for something else—as a down payment on single-payer health coverage, say, or as public investment in decarbonization as part of a Green New Deal. Whatever spending we think most urgent or politically practical, we could borrow an extra percent of GDP or so a year to pay for it and leave the long-term debt picture looking no worse than before.
Whatever level of federal spending you thought would keep the debt on a reasonable path a year ago, you should think that number is $2 trillion higher today.
To be clear, CBO scoring doesn’t actually work this way. Budget proposals are evaluated relative to the baseline, wherever that happens to be. So, the change in the interest assumption will have only a marginal effect on the score for individual bills. However, if there is any rational content to the CBO scoring ritual, it has to involve some sort of judgement about what level of debt is reasonable, relative to GDP. If you take CBO debt forecasts seriously—as almost everyone in the policy world at least claims to—then lower interest rates mean more space for new borrowing.
Lower future interest rates also have implications for stabilization policy. They mean that in the next recession, whenever it comes, there will be even less space for the Federal Reserve to lower rates to boost demand; and, correspondingly, a greater need for fiscal policy—a point that, fortunately, members of the House Budget Committee clearly understand.
There’s one more, even broader implication of the new forecast. What does it mean that the CBO keeps revising its forecasts of future interest rates downward, even as the federal debt continues to rise? Quite obviously: The tight relationship between a high debt-GDP ratio and rising interest rates—that austerity-promoting economists like to predict—doesn’t exist. The question anyone interested in macroeconomic policy or public budgets should be asking is: If high federal debt doesn’t have any reliable effect on interest rates, then what exactly is its economic cost supposed to be?