Yellen: Higher Rates Necessitate Revenue Boost Amid Rising US Debt Costs

Key Takeaway

• Treasury Secretary Yellen emphasizes the need to boost revenue due to higher long-term interest rates, complicating US deficit control.
• The White House projects inflation-adjusted interest payments stabilizing at 1.3% of GDP, but Goldman Sachs forecasts 2.3% by 2034.
• Biden's budget includes tax hikes on capital gains and high-net-worth households to manage rising debt costs, facing Republican opposition.

Yellen's Fiscal Concerns

Treasury Secretary Janet Yellen highlighted the challenges posed by higher long-term interest rates on U.S. borrowing needs, emphasizing the importance of boosting revenue in negotiations with Republican lawmakers. "We’ve raised the interest-rate forecast," Yellen noted in an interview with Bloomberg News. This adjustment complicates efforts to manage deficits and interest expenses. The Biden administration's budget proposals aim to maintain a sustainable fiscal trajectory, with a focus on inflation-adjusted interest payments relative to GDP. This ratio, which jumped in the past year, is projected to stabilize at around 1.3% over the next decade. Yellen expressed a preference for keeping this ratio below 2%, a more specific target than previously stated.

Goldman Sachs economists, however, project that net real interest payments could reach 2.3% by 2034, a significant increase from their previous forecast of 1.5% five years ago. The Federal Reserve's aggressive rate hikes since 2022 to combat inflation have significantly increased the cost of servicing government debt. The White House's latest budget proposal anticipates 10-year Treasury yields at 3.7% in the early 2030s, up from 2.8% in its proposal three years ago. Treasury-bill rates have also been revised upward by about half a percentage point in long-term projections.

Revenue-Boosting Measures

Yellen underscored the need for deficit reduction measures to keep interest expenses at fiscally responsible levels. "We have included a lot of deficit reduction measures in the budget," she said. The upcoming legislative battle over the 2017 tax cuts, set to expire at the end of 2025, will be crucial. While former President Trump has pledged to extend these cuts, President Biden aims to preserve reductions only for those earning less than $400,000 annually. Yellen emphasized the necessity of new revenue to fund any extended provisions, suggesting the implementation of the 2022 global corporate minimum tax deal as one potential solution.

Biden's budget, released in March, includes tax hikes on capital gains and households worth at least $100 million, among other revenue-raising proposals opposed by Republicans. Yellen noted that if the economy were still in a zero-interest-rate environment, the path for net federal interest costs would be lower. Her views on borrowing costs have evolved, acknowledging that longer-term yields might not decrease as previously anticipated.

Fed's Policy Impact

Federal Reserve Bank of Atlanta President Raphael Bostic discussed the prolonged impact of current monetary policy on economic growth. Speaking to students from the Stanford Graduate School of Business, Bostic noted that inflation has resumed its downward trend after stagnating in the first quarter of 2024. However, he acknowledged that progress is slow. "The last couple of numbers suggest that maybe we have moved past that and inflation is continuing back on its path to 2%, but it is going slow," Bostic said.

Bostic highlighted that the economy's evolution through the pandemic has made people and businesses less sensitive to interest rate changes. Many refinanced their debt at lower rates, muting the impact of the Fed's policy rate. Consequently, Bostic expects the current policy stance to last longer than usual. He also expressed reluctance to reverse course once the Fed starts lowering rates, to avoid creating policy uncertainty.

Street Views

• Goldman Sachs Group Inc. economists (Bearish on US debt outlook):

  "We see the ratio exceeding that tolerance zone — projecting net real interest payments reaching 2.3% by 2034."

• Jason Furman, Harvard University (Neutral on the 2% guidepost for real net interest from GDP):

  "It is based on looking at the experience in other countries, the historical experience in the United States, our gut instinct... I’m not positive it’s right."

Management Quotes

• Janet Yellen, Treasury Secretary:

  "We’ve raised the interest-rate forecast. That does make a difference. It makes it somewhat more challenging to keep deficits and interest expense under control."
  "I don’t have a hard-and-fast rule, but I would not like to see it drift above 2%."
  "We have included a lot of deficit reduction measures in the budget in order to hold the interest expense at a level that we think is fiscally responsible."