Carney: The CBO Slashed Its Deficit and Debt Projections–But They Are Still Too High

The Congressional Budget Office dramatically slashed its forecast for interest rates and the size of the federal government’s debt and deficits.

But even the new projections seem too high, at least in the near-term. And probably in the long-term.

In its annual long-term budget report unveiled Tuesday, the CBO said that federal debt and deficits are now projected to be lower over the next three decades than it projected last year. It now sees debt rising to 141 percent of gross domestic product, 11 percentage points lower than its earlier projection.

Projected deficits are smaller as well. In fact, they are smaller in every single year of the projection.

The CBO also lowered its estimate for interest rates in the coming decades. It now sees real rates on 10-year Treasury notes, that is the yield minus inflation, to average 1.6 percent over the 2019 to 2049 period and to be 2.2 percent in 2048. In its prior estimate, the CBO projected that real rates would average 1.7 percent over the 2018 to 2048 period and would be 2.4 percent in 2048.

The nominal interest yield on 10-year Treasury notes, unadjusted for inflation, is projected to rise to 3.8 percent in 2029 and 4.6 percent in 2049, down from the June forecast that saw yields rising to 4.8 percent by 2049.

The CBO has a poor track record in recent years of forecasting interest rates. As recently as last August, it forecast the nominal 10-year rate to be 3.5 percent in the April through June quarter of this year, up from 2.9 percent at the end of 2018. The yield on the 10-year Treasury is now just 1.9 percent.

In a sign that the CBO may still be overestimating interest rates, the current projections see the average 10-year yield at 3.4 percent for this year. Unless interest rates jump much higher in the latter half of this year, when the Fed is widely expected to begin cutting short-term rates, that is certain to be wrong.

The estimate has the 10-year yield jump to an average of 3.6 next year, higher than it has been since 2008. That also is likely to prove too high. Last year’s projection had the rate a tick higher, at 3.7 percent. A one-tenth of a percentage point adjustment hardly seems in keeping with the reality that rates fell by a full percentage point in the first half of this year.

That leaves little room for confidence about the CBO’s projections for the long-term path of rates. They start out at an unrealistically high baseline and rise from there.  If we take the CBO’s estimate that the 10-year yield will be around 35 percent higher by 2049 than it is today but start with a baseline based on a more realistic 2.1 percent yield, the 10-year yield rises to just 2.9 percent by the end of the time horizon.

Getting interest rates wrong has big consequences for the CBO’s economic projections. Lower rates in the coming years mean a smaller share of government spending would go to servicing the federal debt, effectively lowering the estimated future deficits. The CBO says that if interest rates are on average one percentage point lower than forecast over the next 40 years than it expects, total federal debt will be just 107 percent of gross domestic product, up less 2 percentage points from the end of 2018.

If it were as low as 2.9 percent by 2049, the debt to GDP ratio would actually fall.