February 28, 2022

Federal Reserve Chair Jerome Powell said the economy no longer needs or wants highly accommodative monetary policies, so the Fed is going to raise interest rates to curb inflation.

However, higher interest rates mean higher borrowing costs. As a result, companies and people will borrow and spend less. That will reduce the upward pressure on inflation.

But it also means mortgage rates will rise and fewer people will likely buy. If demand for homes falls, prices could too. A rate increase could also drag down stock prices as investors will divest from stocks and put money into safer investments.

Worse yet, higher rates could sink the federal budget.

In 2020, the federal budget was $6.6 trillion. About $4.6 trillion was for “mandatory spending,” including Social Security, Medicare, and Medicaid. Another $1.6 trillion was discretionary, including defense, health, justice, agriculture, education, and everything else.

Well, everything else except for $345 billion in interest payments on our federal debt (which is about $30 trillion, by the way). Those payments are just 5.3% of the budget. But that’s more than four times what’s spent on housing and K-12 education each. It’s eight times what’s spent on science, space, and technology.

Priorities aside, higher rates mean the $345 billion allocation will jump – a lot.

A 1% rise in interest rates will increase interest on the debt to $530 billion, which is more than the cost of Medicaid.

A 2% increase, which is possible by 2023, would bring debt interest to $750 billion. That’s about as much as all defense spending.

If interest rates went up 3%, we’d spend nearly $1 trillion on interest alone. That’s about 20% of total federal tax revenue and close to the annual cost of Social Security benefits.

Short of a devastating tax hike, which would be political suicide, how does this get fixed? It almost seems unbelievable that we had a surplus not too long ago.