Figure 14-2: Increases in total domestic debt drive the prime rate
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: Dramatic increases in government borrowing in 2010 and after, together with a return to Y/Y growth in borrowing by consumers and corporations, may lead to an upturn in Y/Y growth in Total Domestic Nonfinancial Debt during the next few years. If this occurs, higher interest rates would likely follow by 2012 and 2013.
