Ballparking the cost of credit

...economic forecasts and statistics are often based on guesstimates.

- Wikipedia

I had reason recently to read again Steve Randy Waldman's Persnickety followups on inequality and demand. I should probably read the Cynamon/Fazzari paper he links. But I got distracted by a shiny object at the end of his post. This shiny object:

Setting aside everything that interests SRW and his readers, all I want to know at the moment is how the "effective Federal debt interest rate" is calculated. The answer is contained in the uppermost text on that graph:

(FYOINT/GFDEBTN)*100

"Federal Outlays: Interest" divided by "Federal Debt: Total Public Debt". Yeah. Divided by gross Federal debt. That's what I wanted to see. When I left off with this, I thought the gross debt number was the right one to use. It is good to see the thought confirmed on someone else's graph.

In addition to the effective interest rate on Federal debt, the above graph shows the comparable rate for household debt. I'm thinking the Federal rate is a low one, and the household rate a high one, relative to the average for all debt. Consumers on average probably pay a higher rate than businesses, the government a lower rate.

There's about five percentage points difference between the Federal rate and the household rate on Waldman's FRED graph. I'm thinking I want to split the difference and add 2½% to the Federal rate, to get a number I can use for the effective interest rate on all debt in the US.

It's just a guess, but it gives me something to work with.


FRED's FYOINT goes back to 1940. GFDEBTN goes back only to 1966. When you're old as me, 1966 is nothing. I'll use FYGFD instead, as it goes back to 1939. GFDEBTN is quarterly and FYGFD is annual, but I'm not losing anything by going with the annual values, as the interest number is annual anyway.

FYOINT and GFDEBTN are both in millions, while FYGFD is in billions, so I do have to convert for units. But in exchange I get a graph that goes back to 1940:

Graph #2: My guesstimate of the Effective Interest Rate on Total Debt in the US
Note: Using FYGFD (red) takes us back to 1940, GFDEBTN (blue) only to 1966

Oh yeah, that's definitely worth it.

Note that Graph #2 shows a peak at a 10% rate of interest, 2½ points higher than Waldman's green peak. (I've already added the two and a half.)


Now, about debt. FRED's TCMDO includes "credit market" debt. It excludes borrowing done outside of credit markets, as when the Federal government borrows Social Security funds. So I want to subtract from TCMDO the Federal portion of it (which is today about $12 trillion) and to what's left I want to add the gross Federal debt (which is now about $17 trillion). That will give me a number for all the debt I know about:

Graph #3: All the Debt I Know About
Total Credit Market Debt less Federal Debt Held by the Public plus Gross Federal Debt

See how the blue line just curves up and up, until the start of the recent recession? Things are different since that recession. The comments I will be making about the cost of this debt will refer to what was happening before the recent recession. My objective, as always, is to understand what led to the crisis.

Now, if Graph #3 shows the amount of debt, and Graph #2 shows the estimated effective interest rate on all that debt, I can just multiply the numbers together and get the total amount of interest paid in dollars... billions of dollars.

I'll have to not multiply by 100 in figuring the interest rate. Other than that, the top line of Graph #4 will show the line across the top of Graph #3 multiplied by the second line across the top of Graph #2.

Okay, Graph #4:

Graph #4: Estimated Total Interest Paid, billions of dollars

Do me a favor: Check my work. It's early yet, the calculation is complicated, and I've had only one cup of coffee so far this morning.

Visible on this graph in the last four recessions are disturbances to the general uptrend. A small flat spot in 1982. A longer flat spot around 1990. About as long, but down rather than flat around the year 2000. And down again, three or four times as far down, in the most recent recession.

Flat spots are probably visible in the earlier years as well, if you zoom in on the graph and look. But they seem to be getting worse.


Now I want to take Graph #4, showing the money paid as interest, and look at that number relative to GDP:

Graph #5: Estimated Total Interest Paid, relative to GDP

On this graph you can see interest costs rising from the 1950s to the early 1980s. During those years interest rates were going up, and debt was growing like crazy.

Since the early 1980s the graph shows a mild downhill trend. During these years interest rates were going down, and debt was growing like crazy.

Total interest costs in our economy, based on this estimate, range from a low of 6 cents per dollar of GDP (in the early 1950s) to ten cents (in 1970) to 15 cents (in 1980) to 20 cents (in 1990). Today, or at the end of 2012 I suppose, the total cost of interest in this country still amounts to 15 cents for every dollar of GDP.

That's a lot of interest cost, brother.


As you know, to fight inflation our policy restricts the quantity of money. When there is too much money in the economy, reducing the quantity of money (relative to GDP) will reduce inflation. (Before the crisis, I'm saying.) When there's not too much money in the economy, reducing the quantity of money doesn't help; but that's another story.

To fight inflation, policy restricts money. To stimulate growth, policy encourages spending. These policies are contradictory, and they lead to the situation where we have little money and we use a lot of credit.

How much credit do we use? Well, credit we're using is called "debt". Graph #3 shows how much credit we're using. Graph #4 shows what it costs. And Graph #5 compares that cost to the size of our economy.

But suppose our policies had been different for all these years. Suppose that back in the 1960s we realized that there was not too much money in the economy but, rather, too much use of credit. Suppose we had changed our policies then, so that they stopped excessively discouraging the use of money, and started encouraging payback of debt.

It could have been done easily, you know. It's not like we use gold for money. We have a flexible monetary system. The problem is not that we can't keep our monetary balances at optimum. The problem is that we don't know what the optimum is. We think using credit is good for growth. Perhaps you think it still today, even though we have $60 trillion of credit already in use, and everybody thinks it's a burden and a risk, and everybody wants to reduce their debt.

See, this debt problem didn't develop because everybody wants to reduce their debt. It developed because people think using credit is always good for growth, even when there's way too much credit in use already.


The problem isn't people, of course. The problem is policy. We set up policies... No, I refuse to take any blame for it. They set up policies designed to encourage the use of credit and let debt accumulate. And when the use of credit started causing inflation they blamed the money instead, and restricted the money, and still they encouraged the use of credit and the accumulation of debt. And that's how we ended up with $60 trillion of debt and $2.4 trillion of interest cost in a $16 trillion economy.

When there's too much money in the economy, the right way to fight inflation is to restrict the quantity of money. When there's too much credit in use, the right way to fight inflation is to accelerate the repayment of debt.