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INSIGHTi
Low Interest Rates, Part 1: Economic and
Fiscal Implications
Updated February 25, 2019
Since the 2007-2009 financial crisis, U.S. interest rates have been unusually low by historical standards.
This Insight discusses the implications of low interest rates for households and fiscal policy. Its sequel,
Low Interest Rates, Part 2, discusses implications for monetary policy.
Low Interest Rates
When describing interest rate trends, each debt instrument is different. The interest rate on every debt
instrument is determined by market supply and demand for that instrument, and each instrument has
different characteristics, including issuer, maturity length, and liquidity. Analysts often focus on two
specific interest rates to gauge overall interest rate trends—the yield on Treasuries (marketable federal
debt instruments) and the federal funds rate (the overnight interbank lending rate).
Treasury yields play a central role in financial markets because they are highly liquid (easily tradeable)
and are seen as posing negligible default risk, whereas default risk varies from company to company for
private debt. A common benchmark for long-term rates is the 10-year Treasury yield. Figure 1 illustrates
how Treasury yields fell during the financial crisis and have not yet recovered to precrisis levels. Since
2008, 10-year Treasury yields have remained below 4%. Prior to that, yields had not been below 4% since
the early 1960s. Typically, yields rise as an expansion strengthens, but yields are lower today, with the
economy near full employment, than they were at the onset of the recovery. Yields on mortgages and
corporate debt have followed a similar pattern.
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Figure 1. 10-Year Treasury Yields
1953-2018
Source: CRS calculations using data downloaded from St. Louis Fed, FRED.
Notes: Real 10-year Treasury yields are calculated using the Consumer Price Index.
The federal funds rate is important because it is the Federal Reserve’s primary monetary policy target. It
influences, but does not directly determine, other interest rates. The federal funds rate is a very short-term
interest rate; changes in the federal funds rate generally lead to proportionately larger changes in other
short-term interest rates relative to long-term rates. As shown in Figure 2, the Federal Reserve reduced
the federal funds rate to zero in response to the financial crisis—the first time the federal funds rate
reached zero since data were first collected in 1954. Since 2015, the Federal Reserve has been gradually
raising its federal funds target range, currently set at 2.25%-2.5%. Even after these increases, rates have
been this low only once between the early 1960s and the financial crisis (following the 2001 recession).
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Figure 2. Federal Funds Rate
1954-2018
Source: CRS calculations using data downloaded from St. Louis Fed, FRED.
Note: Real federal funds rate is calculated using the Consumer Price Index.
The United States is not the only country with unusually low interest rates—they are low across advanced
economies. Currently, short-term interest rates and 10-year government bond yields are lower in all other
members of the G-7 than in the United States.
One reason that interest rates have been low in this decade is because of low inflation. To compare
interest rates over time, real interest rates are adjusted for differences in inflation. Even after making this
adjustment, interest rates are relatively low by historical standards. The real federal funds rate has been
negative (meaning it is lower than the inflation rate) in most months since the financial crisis. It is not
uncommon for the real federal funds rate to be negative during a recession or when inflation turns out to
be higher than expected. (Because inflation was high at times in the 1970s-1980s, it was probably not the
intention of policymakers or the expectation of market participants for real rates to be negative in those
cases.) But it is uncommon for the real federal funds rate to remain negative throughout the expansion,
even when the economy is currently near full employment. Similarly, 10-year Treasury yields have been
close to zero in real terms since the financial crisis, a phenomenon that has not persisted throughout an
expansion before—although it has happened briefly—in the period covered by Figure 1.
Implications for Households and Businesses
In general, low interest rates are bad for net savers, who earn less on their savings, but good for net
borrowers, who pay less in debt service. When rates are low, they make interest-sensitive spending by
firms and households more affordable. For example, firms make physical investments in plant and
equipment on credit, whereas households purchase consumer durables (e.g., automobiles, appliances) and
housing on credit. Whether low rates are good or bad overall depends on the economic context—arguably,
the economy is currently in a “sweet spot,” where interest rates, inflation, and unemployment are all low.
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Implications for Fiscal Policy
Low interest rates have significantly reduced the federal government’s borrowing costs relative to gross
domestic product (GDP). Although the publicly held debt as a share of GDP has more than doubled since
the financial crisis, reaching its highest level since 1948, interest payments relative to GDP have remained
below their 1980-2000 average, as shown in Figure 3. Lower borrowing costs reduce the overall budget
deficit in a given year, all else equal, reducing the need to cut other spending or raise taxes. However, this
trend is not projected to continue. The Congressional Budget Office (CBO) projects that borrowing costs
will nearly double as a share of GDP over the next 10 years under current policy as the debt increases and
interest rates rise (but remain below precrisis rates).
Figure 3. Net Federal Interest as a % of GDP
FY1962-FY2029
Source: OMB, CBO.
Note: Forecast for 2019-2029 is January 2019 CBO Baseline.
Low interest rates—if they persist—may also assuage fears that the increase in federal debt would “crowd
out” private investment. The crowding out effect occurs when government borrowing pushes up public
and private interest rates, leading private firms to cut back on their investment spending. If crowding out
does not occur, then one of the main negative economic effects of budget deficits is not present.
Author Information
Marc Labonte
Specialist in Macroeconomic Policy
Congressional Research Service
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Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff
to congressional committees and Members of Congress. It operates solely at the behest of and under the direction of
Congress. Information in a CRS Report should not be relied upon for purposes other than public understanding of
information that has been provided by CRS to Members of Congress in connection with CRS’s institutional role.
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