Interest Payments and Growth

In comments to my (admittedly simplistic) posts on optimal tax collections and the optimal size of the deficit, the issue of interest on the debt came up.

So I pulled data for interest (sadly, the OMB only seems to keep it going back to 1962 – so the results are not strictly comparable to the two other posts, for which data went back to 1950), and ran the same analysis. So how do interest payments on the debt affect growth in real GDP per capita?

________1% to 2%___2% to 3%__3% to 4%____4% +
t to t+1____2.71%____2.13%____1.71%____2.14%
t to t+2____2.56%____1.91%____2.19%____2.11%
t to t+3____2.50%____1.81%____2.38%____2.04%
t to t+4____2.46%____1.75%____2.38%____1.98%
t to t+5____2.43%____1.74%____2.41%____1.93%
t to t+6____2.40%____1.75%____2.49%____1.89%
t to t+7____2.30%____1.86%____2.63%____1.89%
t to t+8____2.24%____1.94%____2.65%____1.91%

As an example of how to read the table, the annualized growth rate, over a seven year period beginning in a year when interest payments are between 3% and 4% of GDP is 2.63%.

What does this show? Well, over the short run, say, one to five years, the lower the interest payments on the debt, the faster the growth rate. Put another way, having debt slows down growth because you have to pay interest on the debt. That is money that can’t be spent elsewhere, on more useful things.

The table also shows that in the outyears, interest payments of 3% to 4% of GDP produce the fastest growth rates. My belief – that’s an anomaly. I note that this only occurred 7 times.

So to repeat, the higher the debt and the higher the interest rate, the slower the growth rate of real GDP per capita.

GDP from OMB Table 1.2
Interest on the debt OMB Table 3.2
Real GDP per capita from BEA NIPA Table 7.1.

Note that because interest payment data is for fiscal year, I used real GDP per capita for the third quarter of the calendar year.

As always, if you want my spreadsheet, drop me a line. (This spreadsheet is growing and contains the data for the previous posts as well!)

Correction. Thanks to reader Ken Houghton for pointing out an error in the first sentence below the table.

Correction 2. A second look at the data indicates that my original reasoning for the anomaly was incorrect. My apologies.

Update. I modified the headers of the table slightly to (hopefully) make them more readable.