Risks also arise from the interaction of fiscal and monetary policy in response to higher debt. For example, the Federal Reserve’s large-scale purchases of Treasury securities and other financial assets in response to the pandemic pose risks to the outlook for interest rates. CBO expects the Federal Reserve’s holdings of Treasury securities, measured as a share of GDP, to begin declining after 2024, which would put modest upward pressure on long-term interest rates. There is some risk, however, that participants in financial markets could react adversely to the Federal Reserve’s efforts to taper its holdings of such assets by sharply reducing their demand for Treasury securities, which would cause long-term interest rates to rise rapidly. There is also a possibility that concern about such an adverse reaction by financial market participants could cause the Federal Reserve to delay reducing its holdings of Treasury securities, which would result in lower long-term interest rates for longer than CBO projects in its baseline.
CBO estimated the size of changes in spending or revenues (or both) that would be needed if lawmakers wanted to achieve some specific targets for federal debt held by the public. The agency also assessed the extent to which the size of policy adjustments would change if deficit reductions occurred later, and it examined how waiting to resolve the long-term fiscal imbalance would affect the economy and different generations of the U.S. population.
The Size of Policy Changes
If lawmakers wanted debt in 2050 to remain at roughly its level at the end of this fiscal year (about 100 percent of GDP), they could cut noninterest spending or raise revenues (or do both) in each year beginning in 2025 by amounts totaling 2.9 percent of GDP (see Table 2). In 2025, 2.9 percent of GDP would be about $730 billion, or $2,200 per person. If such an adjustment was made in 2025 and each year thereafter, the budget would show a primary deficit of 1.9 percent of GDP in 2030 and 4.7 percent of GDP by 2050. If such changes came entirely from either revenues or spending, they would amount to a 17 percent increase in revenues or a 14 percent cut in noninterest spending, on average (relative to amounts in CBO’s extended baseline projections). After 2050, growth in spending relative to the size of the economy would probably continue to outpace growth in revenues, and deficits would rise further.