Measuring the Sensitivity of Net Interest Paid to the Business Cycle and to Inflation

Abstract

Net interest paid has been one of the most rapidly growing components of federal government expenditures since 1970. Unlike other components of the budget, public policy actions can have little effect on its rise—especially in the short run. For this reason, it is important to examine the forces “automatically” affecting net interest paid. This article examines the sources of change in net interest paid and provides an analytical framework to estimate the automatic effects of the business cycle and inflation. The framework incorporates the most important factors affecting net interest paid, including interest rates, budget deficits, and outstanding stocks (short-term and long-term debt and direct loans), and highlights the simultaneous relationship between net interest paid and changes in net debt (federal debt outstanding less direct loans outstanding). A sample application of the analytical framework is discussed.