The increase in annual interest payments on federal debt to over $1 trillion in just three years has raised concerns about the U.S. heading towards a fiscal cliff. However, this interest burden is not as catastrophic as some may believe. While interest payments have more than doubled as a percentage of total federal outlays and GDP since 2021, they are still within historical norms when compared to other spending categories like entitlements and defense. In fact, interest payments on federal debt are at a similar level to what they were in the 1980s and 1990s.
Despite the quadrupling of federal debt as a percentage of GDP since 1980, interest payments have not exploded due to lower interest rates. This suggests that the level of public debt has little impact on stock market performance, with historical data showing that increasing levels of debt are actually associated with rising equity prices. This challenges the common belief that ballooning government debt crowds out private borrowers, stifles economic activity, and ultimately harms company earnings and stock prices.
While interest payments remain manageable and well within historical ranges, not all public borrowing is created equal. Investments in projects that are expected to provide future returns that exceed the cost of financing can be effective at boosting productivity and GDP growth. This return on investment is crucial for sustaining economic growth and raising median incomes. However, not all government expenditures offer a positive return, with wasteful spending contributing to unnecessary interest payments.
The debate over the increasing size of federal interest outlays points to a larger discussion about federal spending priorities. While some may view certain expenditures, such as Medicare, as wasteful, others may argue that they serve a socially desirable purpose. The key is to distinguish between investments that will yield long-term benefits and expenditures that contribute to interest payments without providing measurable returns. This highlights the importance of prudent fiscal management to ensure that public debt is used effectively to drive economic growth.
Moving forward, policymakers must carefully consider the impact of public spending on interest payments and prioritize investments that will generate positive returns for the economy. While public indebtedness can provide flexibility to manage complex economic challenges, it is essential to evaluate the cost-effectiveness of government projects and ensure that taxpayer dollars are used wisely. By investing in projects that boost productivity and drive GDP growth, the U.S. can continue to strengthen its economic position and support sustainable long-term growth.
