Federal Reserve chairman Ben Bernanke has often spoken of the need for the US to get its fiscal house in order, though he’s steered clear of prescribing specific measures to accomplish it.
On Tuesday, he actually did something about it: The Federal Open Market Committee said it would leave short-term interest rates at its current 0.25% level for a really, really extended period—through at least mid-2013.
That was extraordinary—I can’t recall when the Fed has ever telegraphed its policy for that long in advance.
But amid the FOMC’s doleful statements about how weak the economy is, you won’t find one mention of another salutary effect the interest-rate freeze will have: low interest expenses on the national debt.
By keeping rates at rock-bottom levels, the Fed is guaranteeing that through 2013 at least, suddenly rising interest expenses won’t make the deficit even worse.
In 2010 the federal government paid out around $200 million in interest expenses, about 1.4% of GDP, According to the Congressional Budget Office, every percentage point rise in interest rates adds $17 billion in annual interest expenses.
Also, the Fed has quietly extended the maturities of its debt: In 2007 half of the securities it held had maturities of a year or less; the number now is 8%. That, as Professor James Hamilton of UC San Diego explains, allows the Fed to borrow money at practically zero and lend it out at the prevailing long-term interest rates. So, in 2010 it earned a tidy profit of $80 billion, which went back to the US Treasury.
By putting interest rates on hold until mid-2013, Ben Bernanke also takes that issue off the table through next year’s elections, just as President Obama did with the debt ceiling. The Fed may be technically independent, but no Fed chairman wants to be in Congress’s or the president’s cross hairs in an election year. That’s something Ben Bernanke won’t tell you, either.