Q&A – If the Fed Cut Interest Rates, What Would the Impact Be on Federal Debt?

As consumers, when we think of the impact of what a lower interest rate would mean, we tend to think in terms of how it impacts us.

Episode Transcript

Speaker 1 (00:04):
Your questions, Brian's answers. It's time for today's Q and
A of the day. This is the Brian Mud Show. Yeah,
today's Q and A.

Speaker 2 (00:14):
If the Fed cut interest rates, what would the impacts
be on federal debt? This is brought to you by
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maybe for a future Q and A and today's notice
this Brian. One of the arguments President Trump offen states
for the Federal Reserve cutting interest rates is that the
US would pay lesson debt, and thus the federal deficit

(00:56):
would be less if interest rates were lower. How big
of an impact with or be on the federal deficit?
If interest rates were as low as they were in
his first term. Thank you. Okay. So first a word
from the President as he was talking about this yesterday.
We should be less than one percent.

Speaker 1 (01:14):
I think Switzerland is the lowest, at like one half
of a percent.

Speaker 2 (01:18):
We should be lower because without us, there's no world.
It would all go boom, no world. Why are you laughing,
jiel Just think of the big boom.

Speaker 1 (01:26):
It would be another big boom.

Speaker 2 (01:29):
So this is an excellent question that comes with a
slightly more complicated answer than you might be led to think. So,
as consumers, when we think of the impact of what
a lower interest rate would mean, we tend to think
in terms of how it impacts us. For example, if
the Federal Reserve cuts the Fed Funds rate that it
charges banks for the money they lend out. We know
that credit card interest rates are lowered, and if we

(01:51):
take out a new loan, say on a car or
a mortgage, those rates tend to be lower. So where
aware that as well when you take a look at mortgages,
for example, that you can refinance at a lower mortgage
rate if they come down from where you took out

(02:15):
that mortgage originally, and that can provide immediate cost savings
for us. So for those types of reasons, we might
be inclined to think that it would have a similar
impact with the federal government when it's servicing the federal debt. However,
it is not that straightforward or easy. So there are
two truisms when it comes to lower interest rates regarding

(02:37):
the servicing of the federal debt. One, lower interest rates
do reduce the cost of servicing of the debt. However, too,
lower interest rates impact the cost of borrowing going forward,
not existing obligations to the way the federal government goes

(02:58):
about issuing debt to fund deficits. It's through these types
of products the issue treasury bills, treasury notes, treasury bonds,
and treasury inflation protected securities. Okay, And through all those
different products, those different things, they offer debt that you

(03:20):
can buy that is under a year in duration all
the way to thirty years. Okay, So you can buy
something today, you buy a thirty year treasury security, thirty
year treasury bond, whatever that going rate is today, you
get that for the next thirty years, right, So there's

(03:41):
no refinancing that from the federal government. So when you
buy slash invest in those products whatever the duration is
and whatever that rate is, that's what it is. So
unlike your ability to refinance your debt. When rates go down,
the federal government they realize it, US realizes that the
savings from the issuance of new debt and lower interest

(04:03):
rates when higher interest debt investments mature and have been
paid off. Here's how all this comes together into dressing
today's Q and A. Despite the Federal Reserve's interest rate
currently being four and a quarter percent to four and
a half, the average interest rate on the greater than
thirty six trillion in debt ode is three point three

(04:24):
percent three point three due to most of the debt
having been issued at lower interest rates. All right, So therefore, currently,
every time the Treasury issues debt with an interest rate
that is higher than three point three percent, the average
cost of servicing the national debt rises. We need interest

(04:46):
rates to fall below three point three percent to begin
to realize net savings on the cumulative borrowing costs. So,
based on the current average interest rate of three point
three percent, the annual interests fence is about one point
two trillion dollars per year going forward. If interest rates

(05:07):
were as low as they were during President Trump's first term,
when the rate averaged one zero point seventy five percent,
the year one savings would be approximately one hundred and
eighty six billion dollars based on the current federal at
TEL level. If those lower rates could be maintained, the
eventual savings would equal approximately five hundred and sixty two

(05:29):
billion dollars per year. So in other words, we would
save an average of one hundred and eighty six billion
per year until reaching at five hundred and sixty two billion.
So it is a big chunk of change what we're
talking about here. To put that in perspective, the added
interest expense is the equivalent of greater than eight percent

(05:51):
of total federal spending most recently. And think about that.
We just went through his whole budget thing, right, one
big beautiful bill act. We're trying save money. If the
federal government came out and or you know, the Trump
administration came out and said we are cutting a tenth
of the federal government with this, this sounds pretty strong, right, yeah,

(06:14):
And so you can get pretty close to that. You
can effectively accomplish that by getting the interest rates down.
So when you hear Trump talk that way, that is
what he is talking about. You can effectively eliminate the
cost of a tenth of the federal government to us
by simply getting interest rates lower. So, as we're looking

(06:37):
for long term fiscal stability by the federal government, President
Trump is correct the low interest rates are a huge
part of the puzzle. However, it wouldn't be a quick
fix or a long term panacea without other factors weighing
in as well. However, if lower interest rates were obtained
and maintained, along with an economy growing faster than what
we've seen or has recently been projected, as was the

(06:58):
case or in President Trump's first term, I'd be possible
to turn the tide on the federal dead and deficit,
especially based on what we saw with the federal government
unexpectedly posting a budget surplus two out of the previous
three months.