Fundamentals Update: US Budget Update

US Budget Update

Fundamentals Update as at 23 February 2014 by Lorenzo Beriozza

Under current tax and spending laws, the CBO projects the federal budget deficit will shrink over the next few years, reaching a low of $478 billion (2.6% of GDP) in fiscal year 2015.

However, several forces are expected to increase deficits later this decade. If current laws do not change, the CBO puts the deficit up to 4% of GDP in ten years. And the overall debt in the hands of the public, under the same current-law assumptions, will equal 79% of GDP in 2024 and be on an upward path.

The factors behind this uncomfortable scenario include an ageing population, rising health care costs, an expansion of federal subsidies for health insurance, and – importantly – growing interest payments on federal debt.

The dramatic decline in interest rates since 2007 has restrained the budgetary cost of servicing the government’s debts. The problem going forward is that once interest rates reach an irreducible minimum and stop falling, the incremental beneficial effect disappears.

The situation gets more extreme if market interest rates rise. If the CBO interest rate assumptions came to pass, net interest payments would equal 82% of a projected $1.1 trillion budget deficit in 2024.

The Federal Reserve is not expected to announce a policy of pegging interest rates for the benefit of the budget. But it did so during the wartime period of the 1940s, illustrating that independent central banks are a luxury of normal times, to be compromised in extreme circumstances.


Source: Credit Suisse