How Much Debt Is Too Much? Inflation Pushes The Cost Of Debt

With the U.S. deficit increasing due to the ongoing clash in Washington over raising the Debt ceiling, it is important to assess how much debt is too much. The purpose of this article is to analyze the current situation & determine if an increase in the Debt limit is necessary.

Overview of current U.S. deficit 

Higher borrowing costs are widening the U.S. deficit as there is an ongoing clash in Washington over raising the Debt ceiling. This brings up the important question that how much debt is too much.

As the Nation’s debt is looming over its debt limit of $31.4 trillion – a debate has evolved/ started over borrowing costs. According to some newspaper reports, the New Government are demanding that Congress only to approve an increase in the Debt limit only when it is accompanied by unstipulated spending cuts. 

Treasury Secretary Ms. Janet Yellen’s letter

As we have already stated earlier that the Treasury Secretary Ms. Janet Yellen, has written a letter stating that the Treasury will unable to pay all of the nations bills on time as early as June if Congress doesn’t raise the Debt limit

House Speaker Mr. Kevin McCarthy’s Speech

On 6^th February 2023, House Speaker Mr. Kevin McCarthy in his speech outlined three components on the issue of the Debt limit negotiation deal – with limited details. They are one, he is open to sitting down and negotiating, two to find a common ground and third was to move towards a “Balanced Budget” (i.e. balance between revenue and expenditure) over time. 

Monthly Budget Review of Congressional Budget Office (CBO) Estimates

According to the Monthly Budget Review of Congressional Budget Office (CBO) Estimates, January 2023, for the first four months of Fiscal Year (FY) 2023 the Outlays were $1.9 trillion which is $157 billion more than the corresponding period last year. 

When it comes to interest on the Public Debt, it is increased by $58 billion (or) increased by 41%, this is significantly higher than the previous fiscal year (i.e. 2022) for the corresponding period (i.e. four months of the first fiscal year).

There are no Receipts (whereas in FY2022 – it was $81 billion) collected during the first four months of 2023, this is one of the reasons for the net increase in outlays. 

The CBO estimates stated that the Federal Budget Deficit was at $459 billion in the first four months of FY 2023. This is $ 200 billion more than the shortfall recorded in the same period last year. 

The Outlays have increased by 9% and Revenues are down by 3% from October to January (i.e. first four months of this FY 2023) compared to the corresponding period of last year (i.e. FY2022).

In January 2023, the Federal Government incurred a deficit of $38 billion compared to a surplus of $ 119 billion in January 2022. This is a difference of $ 157 billion. 

There are shifts in payments in January, in both Fiscal years (i.e. 2022 & 2023). This shift in payments from January into December has decreased the outlays by $26 billion in January 2023 and $ 24 billion in January 2022. If there is no shift in those payments then the deficit would have been $64 billion in January 2023 and the Surplus would have been $94 billion in January 2022.

Inflation pushes the Cost of Debt 

Spending more for payment of Interest on Debt is among the largest spending this year. This is a result of an increase in benchmark interest rates from near zero for almost 2 years during the pandemic. 

When inflation remains below tolerance leave, then there is hardly any reason to worry about a growing National Debt. However, when there is an increase in prices then it becomes a worrisome factor. It is because when there is inflation the Federal Reserve will increase the Benchmark interest rates to curb inflation. This increase in benchmark interest rates will affect the payment of Interest on Public Debt.

The above graph shows Total Public Debt and Federal Interest Payments as percentages of GDP. The graph depicts that the Interest Payments are increasing even though overall Debt is falling. 

The Total Public Debt Percent of GDP has come down from 134.84% in Q2 of 2020 to 120.23% in Q2 of 2023. However, Interest Payments as a percentage of GDP have increased from 1.64%  in 2020 to 1.87% in 2023.

This increase in Interest payment on Public Debt is due to Federal Reserve’s increase in benchmark interest rates to curb inflation. In other words, the prevailing inflation pushes up the debt costs. 

CBO projections last year about Fed’s hike on interest rates went completely wrong. Unfortunately, that didn’t happen as the Fed raised the benchmark interest rates faster than CBO expected. It has pushed its benchmark rate between 4.5% t0 4.75%  – this level was reached in 2007.

An increase in the interest rates has pushed up yields on Treasury bills, which is 3.73% on the 10-year Treasury bill (as of 10^th February 2023) compared to 1.78% on the same date last year. This is approximately an increase of around 2%. This will add to the woe for the Federal Government in interest cost on debts.   

The spending on debt (i.e. Cost of Debt) can pose serious problems to the Nation’s Budget. This will affect the public borrowing and also can crowd out private investment which will affect the economy as a whole. Irrespective of where the interest rate stands, it is essential to address the looming National debt or Debt limit problem at the earliest. 

Conclusion

The increase in interest rates due to inflation has significantly increased the cost of debt & could pose serious problems to the nation’s budget. In order to avoid future economic problems, it is important to address the looming National debt or Debt limit crisis as soon as possible. As the current fiscal year’s deficit already increasing, Congress might have to increase the Debt limit in order to avoid any detrimental effects to the economy.

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