The Economy Got Used to Low Borrowing Costs. Their Exit Could Pose Risks.
New York Times
Aug-22-2026
The era of low interest rates is over. The economic hangover is just beginning.
Interest rates on long-term U.S. government debt hit their highest level in nearly 20 years this week, and yields are also rising for government bonds around the world. An intervention by the Treasury Department on Wednesday only fleetingly arrested the rise in rates, which have led to higher borrowing costs for home buyers, businesses and the federal government itself.
Rates are being driven higher by a variety of forces. Stubborn inflation is being exacerbated by the war with Iran and there are questions about how forceful the Federal Reserve will be to tame it. Aggressive borrowing by artificial intelligence companies and hopes that the A.I. boom will lead to faster economic growth in the future. And long-brewing concerns about the federal government’s ability to manage its mounting debt load, which this week topped $40 trillion for the first time.
But beyond the specific explanations, economists say, higher rates are in some ways a return to a more normal period. The real aberration, they say, was the nearly two decades of ultralow rates that followed the global financial crisis in 2008. Average interest rates on a 30-year fixed-rate mortgage spent more than a decade below 5 percent, and short-term interest rates were near zero for years. Even now, bond yields remain low by historical standards, especially in inflation-adjusted terms.
“The interest rates of the last couple of decades were unusually low by historical standards, and we’ve now undone that decline,” said Douglas W. Elmendorf, a Harvard economist who led the Congressional Budget Office in the years after the financial crisis. “We’re back up to a level that actually seemed pretty low when we encountered it 20 years ago.”
But the U.S. economy looks very different since the last time rates were at this level. Households and businesses adjusted to a world in which money was cheap. So did the global financial system. Perhaps most significantly, government debt has tripled as a share of economic output over that period.
All of that could make higher rates, however historically normal they may be, much more painful this time around.
“We got somewhat spoiled,” said Tara Sinclair, an economist at George Washington University who worked in the Treasury Department during the Biden administration. “A lot of our financial systems were pretty substantially reworked around this assumption of pretty low interest rates.”
Higher rates also pose a political problem for President Trump, who campaigned on a promise to improve affordability for inflation-weary Americans. Instead, mortgage rates, which fell during Mr. Trump’s first year back in office, are rising again, and interest rates on auto loans, credit cards and other forms of consumer debt remain elevated.
Mr. Trump spent months haranguing the Fed to slash borrowing costs, and this year appointed a new chairman, Kevin M. Warsh, who he believed would do so. But stubborn inflation, partly a result of Mr. Trump’s decision to go to war with Iran, has taken cuts off the table. Investors now think the Fed is more likely to raise rates this year than anything else.
But even if Mr. Trump were to have gotten his wish, the Fed only directly controls short-term interest rates. What matter most to the economy are long-term rates, which help determine what it costs to borrow money to buy a house or build a factory. Those rates are set by market forces as investors buy and sell government bonds. When fewer people want to lend the government money, or demand a higher return for doing so, interest rates rise.
For much of the past two decades, investors’ appetite for U.S. government debt seemed insatiable. They poured money into government bonds during the 2008 financial crisis, when hardly any other asset seemed safe. They kept buying during the anemic economic recovery that followed, when pension funds, wealthy individuals and other savers had more cash on hand than there were attractive places to invest it.
The Fed was also a voracious buyer of government debt, as it turned to untested measures to shore up the economy by keeping a lid on borrowing costs. By ensuring strong demand for Treasury bonds, policymakers pushed up prices and put downward pressure on long-term interest rates. Bond yields move inversely to prices.
The United States, and to a lesser degree its peers around the world, took advantage of the opportunity to borrow cheaply, running large deficits even as the economy improved. Despite giving occasional lip service to the need for fiscal responsibility, Republicans and Democrats alike continued to cut taxes and increase spending.
Then came the Covid-19 pandemic, which shut down whole sectors of the economy and left tens of millions of people out of work. The federal government responded in dramatic fashion, providing trillions of dollars in aid to households and businesses — virtually all of it borrowed money. So did the Fed, which bought unlimited quantities of government debt and a range of other securities.
Economists largely cheered the aid efforts, although some warned that the final spending package, under President Joseph R. Biden Jr., was larger than it needed to be and would ultimately fuel inflation. Investors showed no hesitation, either, snapping up the debt at rock-bottom interest rates.
But many economists argued that the federal government should rein in deficits once the crisis passed. That didn’t happen. The tax-and-spending bill that Mr. Trump signed last year will add more than $4 trillion to the deficit over the next decade, according to the latest estimate from the nonpartisan Congressional Budget Office.
Investors’ concerns about the federal government’s fiscal trajectory are contributing to the recent rise in bond yields, said Hanno Lustig, an economist at Stanford University who has studied the Treasury market. For decades, investors paid a premium — in the form of a lower yield — for the safety and liquidity provided by government bonds. Today, that premium has largely disappeared.
The problem, Mr. Lustig added, is that deficits that looked sustainable when interest rates were lower now look much less so.
“Now, you’re left with a fiscal position that was constructed for a low-rate regime that is gone, at least for now,” he said.
Already, the Congressional Budget Office estimates that the federal government will spend more than $1 trillion on interest payments this year, more than it spends on any program other than Social Security or Medicare. That figure is expected to rise sharply over the next decade even if interest rates remain relatively stable.
If, instead, interest rates continue to rise, that will push up the cost of servicing the debt, which will make the fiscal picture look even worse. That, in turn, could spook investors, leading them to demand still higher returns for the risk of lending the government money — a self-perpetuating cycle known as a fiscal crisis.
Few economists think such a crisis is imminent. But they say the risks are rising.
“Economists cannot predict when a crisis will occur because it’s not just a matter of a single number on the debt clock,” Mr. Elmendorf said. “It is people’s perceptions of a government’s ability to manage its finances.”
Scott Bessent, the Treasury secretary, argued on Thursday that the United States could grow its way out of its debt problem.
Economists acknowledge that there are new sources of growth, such as those stemming from the A.I. boom. But the pace at which the debt has compounded makes catching up hard to do. Those A.I. companies have also flooded the market with a torrent of new debt as they seek to fund their expansion plans, in effect competing with the government for a limited pool of investor capital.
What is more, faster growth tends to lead to higher interest rates, though for benign rather than troubling reasons.
The bottom line: The era of low rates is unlikely to return anytime soon.
For the Fed, that could mean that the “neutral rate” — the interest rate that neither speeds up growth nor slows it down — is higher than in the recent past. Most policymakers now estimate that the neutral rate is just above 3 percent, up from 2.5 percent before the pandemic.
With the economy on steady footing and inflation too high for the central bank’s liking, the primary debate that has divided policymakers is whether the overnight rate that the Fed sets — currently at a range of 3.5 percent to 3.75 percent — is applying any restraint on the economy.
If the answer is yes, the Fed can feel confident that inflation will over time ease back to its 2 percent target, a goal it has been missed now for half a decade. But if the answer is no, the central bank faces pressure to act, or risk contributing to an even more persistent inflation problem.
Policymakers who have called for higher borrowing costs — of which there are now several — point to the economy’s resilience as a clear sign that rates are too low.
“If you just observe the real economy backdrop and you observe the markets, it tells you that rates aren’t restrictive,” said Robert Sockin, chief U.S. economist at PGIM. He thinks the Fed should raise rates by 0.75 percentage points over its next three policy meetings before pausing to assess how the economy is faring. Absent that, Mr. Sockin said, the Fed should feel “no confidence” that inflation would return to the 2 percent target anytime soon.
These doubts have injected yet more uncertainty into the bond market, contributing in part to the move higher in long-run interest rates. If inflation remains high and the Fed does not act, bond investors will demand higher returns to compensate them.
As such, some investors argue that a Fed that is more aggressive in stamping out inflation could over time help to keep a lid on longer-term rates.
The urgency around rate rises, however, will depend in large part on the incoming economic data.
“If inflation doesn’t slow, the empirical evidence builds that there is not enough monetary policy restraint to bring inflation to the target,” said Roger Hallam, global head of rates at Vanguard. “The data has to provide the rationale for them not to raise rates.”
Aug-22-2026
The era of low interest rates is over. The economic hangover is just beginning.
Interest rates on long-term U.S. government debt hit their highest level in nearly 20 years this week, and yields are also rising for government bonds around the world. An intervention by the Treasury Department on Wednesday only fleetingly arrested the rise in rates, which have led to higher borrowing costs for home buyers, businesses and the federal government itself.
Rates are being driven higher by a variety of forces. Stubborn inflation is being exacerbated by the war with Iran and there are questions about how forceful the Federal Reserve will be to tame it. Aggressive borrowing by artificial intelligence companies and hopes that the A.I. boom will lead to faster economic growth in the future. And long-brewing concerns about the federal government’s ability to manage its mounting debt load, which this week topped $40 trillion for the first time.
But beyond the specific explanations, economists say, higher rates are in some ways a return to a more normal period. The real aberration, they say, was the nearly two decades of ultralow rates that followed the global financial crisis in 2008. Average interest rates on a 30-year fixed-rate mortgage spent more than a decade below 5 percent, and short-term interest rates were near zero for years. Even now, bond yields remain low by historical standards, especially in inflation-adjusted terms.
“The interest rates of the last couple of decades were unusually low by historical standards, and we’ve now undone that decline,” said Douglas W. Elmendorf, a Harvard economist who led the Congressional Budget Office in the years after the financial crisis. “We’re back up to a level that actually seemed pretty low when we encountered it 20 years ago.”
But the U.S. economy looks very different since the last time rates were at this level. Households and businesses adjusted to a world in which money was cheap. So did the global financial system. Perhaps most significantly, government debt has tripled as a share of economic output over that period.
All of that could make higher rates, however historically normal they may be, much more painful this time around.
“We got somewhat spoiled,” said Tara Sinclair, an economist at George Washington University who worked in the Treasury Department during the Biden administration. “A lot of our financial systems were pretty substantially reworked around this assumption of pretty low interest rates.”
Higher rates also pose a political problem for President Trump, who campaigned on a promise to improve affordability for inflation-weary Americans. Instead, mortgage rates, which fell during Mr. Trump’s first year back in office, are rising again, and interest rates on auto loans, credit cards and other forms of consumer debt remain elevated.
Mr. Trump spent months haranguing the Fed to slash borrowing costs, and this year appointed a new chairman, Kevin M. Warsh, who he believed would do so. But stubborn inflation, partly a result of Mr. Trump’s decision to go to war with Iran, has taken cuts off the table. Investors now think the Fed is more likely to raise rates this year than anything else.
But even if Mr. Trump were to have gotten his wish, the Fed only directly controls short-term interest rates. What matter most to the economy are long-term rates, which help determine what it costs to borrow money to buy a house or build a factory. Those rates are set by market forces as investors buy and sell government bonds. When fewer people want to lend the government money, or demand a higher return for doing so, interest rates rise.
For much of the past two decades, investors’ appetite for U.S. government debt seemed insatiable. They poured money into government bonds during the 2008 financial crisis, when hardly any other asset seemed safe. They kept buying during the anemic economic recovery that followed, when pension funds, wealthy individuals and other savers had more cash on hand than there were attractive places to invest it.
The Fed was also a voracious buyer of government debt, as it turned to untested measures to shore up the economy by keeping a lid on borrowing costs. By ensuring strong demand for Treasury bonds, policymakers pushed up prices and put downward pressure on long-term interest rates. Bond yields move inversely to prices.
The United States, and to a lesser degree its peers around the world, took advantage of the opportunity to borrow cheaply, running large deficits even as the economy improved. Despite giving occasional lip service to the need for fiscal responsibility, Republicans and Democrats alike continued to cut taxes and increase spending.
Then came the Covid-19 pandemic, which shut down whole sectors of the economy and left tens of millions of people out of work. The federal government responded in dramatic fashion, providing trillions of dollars in aid to households and businesses — virtually all of it borrowed money. So did the Fed, which bought unlimited quantities of government debt and a range of other securities.
Economists largely cheered the aid efforts, although some warned that the final spending package, under President Joseph R. Biden Jr., was larger than it needed to be and would ultimately fuel inflation. Investors showed no hesitation, either, snapping up the debt at rock-bottom interest rates.
But many economists argued that the federal government should rein in deficits once the crisis passed. That didn’t happen. The tax-and-spending bill that Mr. Trump signed last year will add more than $4 trillion to the deficit over the next decade, according to the latest estimate from the nonpartisan Congressional Budget Office.
Investors’ concerns about the federal government’s fiscal trajectory are contributing to the recent rise in bond yields, said Hanno Lustig, an economist at Stanford University who has studied the Treasury market. For decades, investors paid a premium — in the form of a lower yield — for the safety and liquidity provided by government bonds. Today, that premium has largely disappeared.
The problem, Mr. Lustig added, is that deficits that looked sustainable when interest rates were lower now look much less so.
“Now, you’re left with a fiscal position that was constructed for a low-rate regime that is gone, at least for now,” he said.
Already, the Congressional Budget Office estimates that the federal government will spend more than $1 trillion on interest payments this year, more than it spends on any program other than Social Security or Medicare. That figure is expected to rise sharply over the next decade even if interest rates remain relatively stable.
If, instead, interest rates continue to rise, that will push up the cost of servicing the debt, which will make the fiscal picture look even worse. That, in turn, could spook investors, leading them to demand still higher returns for the risk of lending the government money — a self-perpetuating cycle known as a fiscal crisis.
Few economists think such a crisis is imminent. But they say the risks are rising.
“Economists cannot predict when a crisis will occur because it’s not just a matter of a single number on the debt clock,” Mr. Elmendorf said. “It is people’s perceptions of a government’s ability to manage its finances.”
Scott Bessent, the Treasury secretary, argued on Thursday that the United States could grow its way out of its debt problem.
Economists acknowledge that there are new sources of growth, such as those stemming from the A.I. boom. But the pace at which the debt has compounded makes catching up hard to do. Those A.I. companies have also flooded the market with a torrent of new debt as they seek to fund their expansion plans, in effect competing with the government for a limited pool of investor capital.
What is more, faster growth tends to lead to higher interest rates, though for benign rather than troubling reasons.
The bottom line: The era of low rates is unlikely to return anytime soon.
For the Fed, that could mean that the “neutral rate” — the interest rate that neither speeds up growth nor slows it down — is higher than in the recent past. Most policymakers now estimate that the neutral rate is just above 3 percent, up from 2.5 percent before the pandemic.
With the economy on steady footing and inflation too high for the central bank’s liking, the primary debate that has divided policymakers is whether the overnight rate that the Fed sets — currently at a range of 3.5 percent to 3.75 percent — is applying any restraint on the economy.
If the answer is yes, the Fed can feel confident that inflation will over time ease back to its 2 percent target, a goal it has been missed now for half a decade. But if the answer is no, the central bank faces pressure to act, or risk contributing to an even more persistent inflation problem.
Policymakers who have called for higher borrowing costs — of which there are now several — point to the economy’s resilience as a clear sign that rates are too low.
“If you just observe the real economy backdrop and you observe the markets, it tells you that rates aren’t restrictive,” said Robert Sockin, chief U.S. economist at PGIM. He thinks the Fed should raise rates by 0.75 percentage points over its next three policy meetings before pausing to assess how the economy is faring. Absent that, Mr. Sockin said, the Fed should feel “no confidence” that inflation would return to the 2 percent target anytime soon.
These doubts have injected yet more uncertainty into the bond market, contributing in part to the move higher in long-run interest rates. If inflation remains high and the Fed does not act, bond investors will demand higher returns to compensate them.
As such, some investors argue that a Fed that is more aggressive in stamping out inflation could over time help to keep a lid on longer-term rates.
The urgency around rate rises, however, will depend in large part on the incoming economic data.
“If inflation doesn’t slow, the empirical evidence builds that there is not enough monetary policy restraint to bring inflation to the target,” said Roger Hallam, global head of rates at Vanguard. “The data has to provide the rationale for them not to raise rates.”
