In the face of a long-term outlook for higher interest rates, Treasury Secretary, Janet Yellen has stressed the significance of ramping up revenue amidst negotiations with Republican lawmakers. This comes at a time when the challenge of keeping US borrowing needs in check intensifies.
Interest Rates and Budget Proposals
Yellen, in her interview with Bloomberg News, made it clear that a rise in the interest-rate forecast poses a challenge to maintaining control over deficits and interest expenses. This was in reference to the budget proposals of the Biden administration, which she believes will ensure the nation maintains a sustainable fiscal trajectory.
Yellen emphasized on the metric of inflation-adjusted interest payments compared with GDP. While this ratio has increased in the past year, the White House expects it to stabilize at around 1.3% in the next decade.
“I don’t have a hard-and-fast rule, but I would not like to see it drift above 2%,” she said, in her most specific comments yet on that guidepost.
Economists’ Predictions
Contrarily, economists from Goldman Sachs Group Inc. project the ratio to exceed the tolerance zone, expecting net real interest payments to reach 2.3% by 2034. Such predictions are worsened by soaring interest rates, a significant reason for which is the Federal Reserve’s aggressive rate hikes since 2022 to combat inflation.
In its latest annual budget proposal, the White House projected 10-year Treasury yields at 3.7% in the early 2030s, significantly higher than the 2.8% seen in its proposal three years before.
Fiscal Responsibility and Tax Negotiations
Yellen highlighted the inclusion of several deficit reduction measures in the budget to maintain the interest expense at a fiscally responsible level. She also indicated an impending tax negotiation, referring to the legislative battle over tax cuts passed in 2017 under former President Donald Trump that are due to expire at the end of 2025.
While Trump has pledged to extend the cuts, President Joe Biden wants to preserve reductions only for those earning less than $400,000 a year. On the other hand, Yellen suggested in the interview that the revenue from tax cuts that aren’t extended should probably be used for deficit reduction.
Funding Provisions and Tax Hikes
Yellen stated the necessity of paying for the extended provisions through new revenue sources. One such source could be the implementation of the global corporate minimum tax deal. However, she mentioned, “You need to do more than that, but that’s a pay-for.”
Biden’s budget, released in March, also includes tax hikes on capital gains and on households worth at least $100 million. Such revenue-raising proposals are opposed by Republicans.
Furman’s Doubts
Yellen noted that if we were back in the zero interest world, the path for net federal interest costs would be lower. However, her views on where borrowing costs will settle over time appear to have shifted.
While many observers focus on the overall debt-to-GDP ratio, Jason Furman and Lawrence Summers of Harvard University argued in a 2020 paper that policymakers should instead aim to keep real net interest from rising above 2% of GDP.
“It is based on looking at the experience in other countries, the historical experience in the United States, our gut instinct,” Furman said. “I’m not positive it’s right.”
