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Eventual US rate rises may force budget spending cuts

Tuesday, August 20, 2019

Subject

US debt dynamics.

Significance

The Federal Reserve (Fed) responded to the debt bubble built up in the United States ahead of the 2008-09 crisis by lowering its main interest rate and buying bonds. The Fed succeeded in the sense that there have been no spectacular failures in recent years, unlike in Europe, where banks have failed despite passing stress tests. The aim was to support credit markets and discipline bad actors, but the policies have largely allowed the federal government to finance deficits cheaply and allowed non-financial businesses to borrow at low rates.

Impacts

  • Lower rates for even longer are raising the amount of low-rated debt being taken out with relaxed covenants; concerns could escalate.
  • If rate tightening comes sooner and faster than expected, the government will be pressured to cut borrowing to ward off a credit downgrade.
  • Cancelling student loans and reducing college costs will be a key topic during the 2020 election campaign.

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