Bill Clinton has convinced many lawmakers that the $792 billion Republican tax cut plan would be bad for the economy because it would divert the budget surplus away from reducing the national debt which, he insists, is critical to keeping interest rates low. While this claim may seem intuitive to many Americans, the fact is Clinton is wrong. The record of the last 18 years plainly shows that there is no relationship between the size of the national debt – nor annual budget deficit for that matter – and interest rates.
The Reagan-era 1980s, which Clinton decries, are a perfect example. According to the latest Economic Report of the President, the interest rate on new home mortgages fell from 14.70 percent in 1981 (Ronald Reagan’s first year in office) to 9.19 percent in 1988 (his last). This 37 percent drop in home mortgage rates occurred while the federal debt grew by more than 160 percent from $785 billion to $2.051 trillion. Since 1988, mortgage interest rates have fallen another 23 percent – to 7.07 percent – while the debt held by the public jumped 81 percent – to $3.72 trillion. Similar patterns, or lack thereof, can also be seen with the federal deficit.
While the chart below clearly shows that interest rates have fluctuated over the past 18 years, these fluctuations track closely to changes in the inflation rate, not the size of the federal debt. So if Clinton is looking for factors to credit for falling interest rates, he should thank the Federal Reserve Board, not the federal Treasury.