What the Record Federal Deficit Means for Bank Rates
March 01, 2010
At the beginning of February 2010, President Barack Obama announced a budget plan which will result in a record $1.6 trillion federal deficit. What does this mean for bank rates? A mixed bag, but potentially more bad than good.
According to figures from the New York Times, this year's deficit would be the largest since World War II. It should be noted that the building of this deficit has been a thoroughly bipartisan achievement, as Obama took office facing a $1.3 trillion deficit. Over the past decade, the national debt has grown under both parties' stewardship of the presidency and Congress.
You may be looking at savings account rates, money market rates, and CD rates under 1% and thinking that the situation can't really get any worse for bank rates. Indeed, it is possible that the deficit could have the long-term impact of pushing interest rates up. However, it could also have consequences that are damaging to bank rates. Let's take a look at the possible outcomes.
Three Scenarios for Bank Rates
The mounting federal deficit could affect bank rates in three different ways--not all of which are mutually exclusive.
- Demand for capital could boost bank rates. In basic economic theory, large government debts would mean that people with savings would benefit as a result of simple supply-and-demand: as the government borrows more money, the scarcity of capital drives up interest rates. In other times, concern about a growing deficit has indeed led to higher interest rates. That hasn't been the case for the current situation, though.
- The drag on economic growth could hold bank rates back. While the government is a relatively small part of the economy compared to consumers, it plays a pivotal role in stimulating the economy at key times. A huge deficit limits the government's fiscal policy options--for example, it's harder for a government already in deep deficit to fund new stimulus policies. These fiscal limitations could suppress interest rates, if economic growth stagnates as a result.
- Inflation could eat into bank rates. Perhaps the most insidious threat is that a mounting deficit could devalue the dollar, which would be inflationary. Under this scenario, you might see bank rates rise, but inflation could be rising even faster.
What overhangs all of these possible outcomes is the fact that outsized deficits represent a threat to the basic stability of the financial system.
What Else to Expect: Bring On the Pain
To help bring the deficit under control, President Obama has proposed a freeze on all non-discretionary non-defense spending. That sounds like a good idea, until you realize that that's a relatively small portion of the budget. More will have to be done to seriously address the deficit.
To his credit, President Obama has also proposed a bipartisan commission to address deficit reduction. This type of concentrated approach is needed because any real solution will involve some pain--that is, cuts to entitlement programs and/or new taxes.
Of course, Congress does not handle pain well, so expect attempts to address the deficit to come as much as possible in the form of hidden fees and taxes. For example, one proposal is for a new tax on large banks. Banks aren't very popular on Main Street these days, so don't expect howls of protest--until people realize that those taxes will ultimately come out of their own pockets in the form of lower savings account rates, money market rates, and CD rates.
It's almost certain that the deficit won't be closed without some pain. Here's hoping that bank rates don't feel more than their fair share of it.
