Treasury Secretary Janet Yellen said the prospects for higher long-term interest rates will make it harder to rein in U.S. borrowing needs, adding to the importance of raising revenues in negotiations with Republican lawmakers.
“We have raised the interest rate forecast,” Yellen noted in an interview with Bloomberg News on Friday. “That certainly makes a difference. It makes it a little more difficult to keep deficits and interest costs under control.”
Yellen referenced the Biden administration’s budget proposals, which she said will keep the nation on a sustainable fiscal path. She reiterated her emphasis on the measure of inflation-adjusted interest payments compared to GDP. That ratio has increased over the past year, but the White House expects it to stabilize at about 1.3% over the next decade.
“I don’t have a hard and fast rule, but I wouldn’t like to see it go above 2%,” she said in her most specific comment yet on that signpost. She has previously said the government’s forecasts generated “historically normal” debt levels.
Economists at Goldman Sachs Group Inc. on the other hand, see that the ratio is higher tolerance zone– with net real interest payments projected to reach 2.3% in 2034. This is evident from a new analysis released on Wednesday. Five years ago the bank’s forecast was 1.5%.
Rising interest rates are a major reason why the outlook has deteriorated. The Federal Reserve aggressively raised interest rates starting in 2022 to combat inflation, making it more expensive for the government to pay off its debt.
In its latest annual budget proposal, the White House forecast 10-year Treasury yields at 3.7% early 1930s – almost a full percentage point higher than the 2.8% seen in her proposal three years earlier. Government bond yields, which closely match the Fed’s interest rate, have risen by about half a percentage point in these longer-term projections.
“We have included many deficit reduction measures in the budget to keep interest costs at levels that we believe are fiscally responsible,” Yellen said. She spoke to Bloomberg News in Stresa, Italy, on the sidelines of a Group of Seven meeting for finance ministers and central bank governors.
“We are going to start tax negotiations,” Yellen said, referring to the looming legislative battle over the tax cuts passed in 2017 under former President Donald Trump and set to expire at the end of 2025.
Although Trump has promised to expand the cuts, President Joe Biden wants to keep the cuts only for those making less than $400,000 a year. As for the revenue from tax cuts that are not extended, Yellen said in the interview that “some of it should probably be used” for deficit reduction.
Yellen said “it will also be necessary” to pay for facilities expanded through new revenue. One way to help finance this is through global business implementation minimum tax agreement, she said. “You have to do more than that, but that is a reward.” On Saturday, she said the US is not yet ready to sign the final version of that agreement.
Biden’s budget, issued in March also includes tax hikes on capital gains and on households worth at least $100 million, along with a slew of revenue-raising proposals that Republicans oppose.
Furman’s doubts
Yellen noted that “if we were back in the world of zero interest rates and thought this would be a sustainable situation over the long term,” the path for net federal interest costs would be lower.
Her views on where borrowing costs will settle over time appear to be shifting. Last October, she said: “It is entirely possible that we will see interest rates fall in the longer term,” as many have said underlying trends that had made them depressed in the past were “still there.”
While many observers focus on the overall debt ratio, Harvard University’s Jason Furman and Lawrence Summers argued in a 2020 paper that policymakers should instead look at preventing net real interest rates from rising above 2% of GDP. Summers, a former Treasury secretary, is a paid contributor to Bloomberg TV.
Furman, a former chief White House economist in the Obama administration, said last year that the 2% guideline is not sacrosanct.
“It’s based on looking at the experiences in other countries, the historical experiences in the United States, our gut feeling,” Furman said in an interview last May. “I’m not sure it’s right.”
