The Devastating Interest Burden of the Debt

Written by Dean Baker   
Wednesday, 17 August 2011 11:04

It is important to remember that most of the people in Washington debates on economic policy do not know much economics. They tend not to be very good at arithmetic either. That is why they were blindsided by the collapse of the $8 trillion housing bubble that wrecked the economy.

As we get endless pontification about the crushing debt burden it is worth touching base with reality on occasion. In that spirit, CEPR brings you the latest data and projections on the ratio of the federal government's interest payments to GDP, courtesy of the Congressional Budget Office (CBO).

Click for Larger Image


Source: Congressional Budget Office.

As the chart shows the interest to GDP ratio is currently at a crushing 1.3 percent, near the post World War II low. However this figure overstates the burden somewhat. Last year the Federal Reserve Board refunded almost $80 billion to the Treasury. This was interest earned on government bonds and other assets it now holds. That leaves a net interest burden of 0.8 percent of GDP, by far the lowest of the post World War II era.

Of course the burden is projected to rise in future years. The baseline projections shows the burden rising to 3.3 percent of GDP by 2021, the end of the forecast period. This baseline is probably overly optimistic in some respects, since it assumes that the Bush tax cuts are allowed to expire and some other items in current law that will probably not happen.

If we adjust the the baseline for these factors, the debt to GDP ratio is projected to be just over 90 percent by 2021, approximately 20 percent higher than in the baseline. If we raise the interest payments by the same percent, then we get a ratio of interest to GDP of 4.0 percent, still not exactly crushing.

It is also worth noting that if the Fed continued to hold $3 trillion or so in assets, and rebated the interest earned on this money to the Treasury, then it would reduce the net burden of the debt by close to 1.0 percent of GDP. This would mean that even in 2021, if we just left everything to run its course, we would still not face as large an interest burden from the debt as the early 90s.

Okay, this arithmetic interlude is over. You can rejoin the Washington elite and start panicking over the debt again.