Walking the High Wire on Interest Rates

President Trump tweets regularly about the Federal Reserve (Fed) board and its chairman, pressuring them to keep interest rates low so the economy can boom. Is there a real concern about raising interest rates too high?

Fed Chairman Jerome Powell’s primary task is to control inflation and help keep the U.S. economy at full employment. Right now, inflation is around 2%, unemployment is at 3.7% and the economy is buzzing at an annualized rate of 3.1%. It seems like the Fed is doing its job, so why the concern?

Higher interest rates result in higher interest payments on U.S. debt, which contributes to an even larger federal deficit. For example, what if the Fed raised interest rates one percentage point more than needed to keep the economy on a growth path with controlled inflation and full employment? This could eventually add another $146 billion (1% x $14.6 trillion publicly held U.S. debt) to the government’s budget in interest payments as current debt matures and is refinanced at this higher rate. The U.S. government is expected to have about a $1 trillion deficit in 2019, and higher interest rates could significantly add to that total. But throughout U.S. history, the government has incurred debt, so why worry?

Maybe there is no worry. The dollar is still the world’s reserve currency. America’s credit rating is sterling, allowing the government to borrow almost at will. But keep in mind, publicly held debt to GDP was 36% in 2008. Today, it’s about 70% or $14.6 trillion. The World Bank suggests sovereign debt to GDP should be around 77% or less. This might explain some of the concern.

In summary, raising interest rates more than needed could have several rippling consequences. It could slow economic growth. It could push government deficits higher in the form of higher debt payments. Plus, a contracting economy could mean higher unemployment, which means fewer tax dollars for the government and an even higher deficit.

While we need to keep an eye on the growing deficit, AMG thinks the Fed has a good handle on how much to raise interest rates.