The latest CBO forecasts show lower interest rates, a lower debt-GDP ratio, and no crowd-out: a reminder to check economic assumptions and a recipe for increased public spending.
Earlier this week, the Congressional Budget Office (CBO) released its Budget and Economic Outlook for the next decade. The numbers that have gotten the most attention are the budget toplines: The federal budget deficit is projected to reach $1.02 trillion in 2020, with total federal debt surpassing $31 trillion. At a time when many people are looking for government to do more, these daunting numbers are already being seized on by deficit hawks to argue that it needs to do less. A closer look at the numbers, however, suggests that deficit fears are overblown.
1. Interest rates have been lower than anticipated, and the CBO has once again lowered its forecast for future rates.
The CBO made a major reduction in its interest rate forecasts last August, implicitly acknowledging that they were wrong to expect interest rates to quickly return to “normal.” But that adjustment was still too conservative: Interest on the federal debt in 2019 turned out to be well below what the CBO was projecting last August. In this latest report, they have revised their interest rate forecasts downward again, projecting $364 billion lower interest spending over 2020–2029 than they did in August. (For comparison, this would cover about 80 percent of the cost of making all public colleges free.) After repeatedly, and wrongly, predicting that interest rates would soon rise back to “normal” levels, the CBO seems to have learned its lesson and is now projecting only a modest and gradual rise in interest rates—less than one percentage point over the next decade. Unfounded fears of future interest rate increases are not a sound basis for policy choices today.
2. With lower interest rates, the costs of public borrowing continue to plunge.
Because interest rates are so low, federal debt-servicing costs are also low, despite the high levels of debt. The notion that today’s high federal debt creates an exceptional burden for government or taxpayers is almost the opposite of the truth. Thanks to low interest rates, we are spending less on debt service today than at almost any time in recent decades. As the figure above shows, the share of federal spending going to interest payments is barely half what it was in the 1990s. A few years ago, before the Federal Reserve (“the Fed”) started raising rates, interest payments as a share of federal outlays were at their lowest-ever levels since before World War II. Under these conditions, it makes no sense to worry about interest payments crowding out other public spending.
3. There’s been no crowding out; government deficits don’t compete with productive private investment.
Falling interest rates don’t just mean that the debt is less of a burden; they also mean that we need to rethink the whole theory of “crowding out”—the idea that federal borrowing competes with private investment for scarce savings (by making the cost of borrowing higher). In reality, larger deficits haven’t meant higher interest rates, and they haven’t reduced private investment. Of course, even if public spending doesn’t compete with private spending, that doesn’t mean the government should spend money on just anything. It’s still important to be sure that spending is on something socially useful, rather than inequality-exacerbating tax cuts for the rich.
4. Debt forecasts depend on economic assumptions, especially about growth.
Thanks to faster-than-anticipated GDP growth, the CBO now projects that the federal government will receive nearly $240 billion more in revenue over the next 10 years than they expected in August.
Why is this relevant? The burden of public debt doesn’t just depend on public spending and revenues; it depends on economic growth. When GDP growth comes in above the forecast, this translates into a smaller debt-GDP ratio (i.e., the denominator in that ratio increases)—a far more important measure than the absolute dollar amount of debt. Faster GDP growth means that any given level of debt is less burdensome.
Though deficit hawks tend to only focus on cutting spending to lower the debt-GDP ratio, the CBO’s new numbers are a reminder that growth (along with interest rates) often has a bigger effect on the ratio in practice. If spending cuts reduce demand and GDP—as, in today’s environment of sluggish growth, they almost certainly would—then they can actually raise the debt-GDP ratio and be self-defeating even in their own narrow terms.
To be clear, while somewhat faster-than-expected growth over the last six months is good news, it is far from a boom; there is still good reason to think that the US economy is operating well below potential. But to the extent that policymakers are worried about the burden of debt, they would do better to focus on boosting demand and growth rather than cutting spending.
Opponents of public investment and a generous social safety net are already using this week’s CBO report to argue that reducing government debt should be the top policy priority, whatever the sacrifices we force people to make. But a more careful reading shows that is wrong. However worried we were about government debt six months ago, the latest CBO numbers should make us less worried—and more confident in our ability to spend more on the major challenges facing our nation.