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Figure 14-2: Increases in total domestic debt drive the prime rate
Figure 14-02
This chart reflects the logical point of view that interest rates are the “cost of money” and, therefore, that increasing rates of growth in total national debt* are likely to drive interest rates higher, and vice-versa.

Over most of the 40-plus years since 1960, rising year-over-year increases in total domestic nonfinancial debt (black line) have led–typically with a one- to three-year lag–to higher interest rates, represented here by the prime rate (green line). Conversely, slowing growth in total domestic nonfinancial debt has usually resulted–with a similar lag–in lower interest rates. One notable anomaly in this relationship was the mid- to late 1980s.

The sharp increase in total domestic nonfinancial debt that resulted in part from the growing federal deficit of the mid-2000s led to higher interest rates in 2005 and 2006 before the financial crisis and the sharp reduction in the Fed Funds Rate led the 10-year Treasury rate lower in 2008 and into 2009.

* “Total domestic nonfinancial debt,” which includes government, consumer, and corporate borrowing.
Current Comment: Increases in government borrowing have been offset by reduced borrowing by consumers and businesses, resulting in only modest growth in total domestic nonfinancial debt. This has reduced the risk that overall growth in debt may spur sharp increases in interest rates.
Sources: Domestic nonfinancial sectors, total debt: Federal Reserve Prime rate: Federal Reserve
Updated: 10/3/15