In the waning days of 2010, with President Obama's stimulus package in full swing in the United States, the interest rate doomsayers were already wringing their hands. The government could manage its borrowing for the time being, they said, but rates would soon rise and make the national debt unsustainable. Three years later, that hasn't happened, yet the doomsayers haven't changed their tune. Will they be wrong again?
In December 2010, the Congressional Budget Office issued a report entitled "Federal Debt and Interest Costs." At the time, the federal government's interest payments had fallen to their lowest level, as a share of GDP, since the 1970s. How was this possible, given the ballooning size of the national debt? In two words: relative value. Investors were desperate for solid, safe assets, and there wasn't much competition from other securities in the wounded, languid markets. So the United States was able to borrow at some of the lowest rates in history.
As the interest rate doomsayers pointed out, this was possibly a temporary situation. If interest rates rose, the United States would be forced to roll over its debts at higher rates; paying interest on time would become much more difficult, if not impossible, unless the overall level of debt were reduced. The CBO was sure that this dark day was coming, and said so in the abstract of its report: "The interest the government pays on that debt is currently low by historical standards as a percentage of GDP but is expected to grow rapidly over the next several years as interest rates rise."
It didn't happen. Since December 2010, interest rates have actually fallen from about 3.3 percent for 10-year Treasurys to 1.9 percent at the time of this writing. The rates were already low in 2010; now, having dropped as low as 1.5 percent last summer, they're still close to rock bottom.
So why were the interest rate doomsayers so wrong? It's not as though Congress and the White House reached any sort of grand bargain to reduce the nation's debt between 2010 and 2013 -- quite the contrary. But during that time, forecasts for the national debt did decrease somewhat because of projections for health-care costs. They fell enough that by 2020, Medicare and Medicaid were expected to cost about $200 billion less per year than the CBO had forecast in March 2010. Also, the Republicans in Congress may have succeeded in blocking more fiscal stimulus, but it's not clear that the credit markets expected any new stimulus measures to pass in the first place.
No, the handling of the nation's fiscal situation probably had very little to do with the path of interest rates. So what did happen? It wasn't the federal government's demand for credit that drove the changes; it was the supply.
Despite the manufactured debt ceiling crisis in 2011 and the general dysfunction in Washington, investors were more than happy to pour billions of dollars into the Treasury's coffers. Some of them came from developing countries where rapid growth continued to generate profits and surplus tax revenues in search of safe homes. Amid the enduring uncertainty in the global economy, the American taxpayer was still seen as one of the world's best bets. At the same time, the Federal Reserve continued to pump new money into the markets. By committing to do so for several more years, it ensured that credit would remain cheap for the public and private sectors.