Will the Fed Lowering Rates Reduce Government Borrowing Costs?

Short version: no.

In my recent post on central banks and independence, I cited Harvard economist Jason Furman in discussing how lower central bank rates won’t necessarily translate into lower private borrowing costs:

The Federal Reserve only sets a handful of interest rates, and those are limited to rates between banks—the discount rate (the rate at which banks can borrow from the Fed) and the interest rate it pays on bank reserves at the Fed.  The Fed tries to influence the Federal Funds Rate (the rate at which banks borrow from each other) through FOMC operations, but they do not set that rate.

The actual rates you and I see are still determined by market factors: risk, inflation, supply, demand, etc.  The Fed cannot set interest rates for mortgages, credit cards, and so on.  It does not have that power.  It tries to influence those rates, yes, but it does not set them.

However, the President has argued that reducing rates would reduce Federal borrowing costs, lowering costs for all Americans.  There are two problems with this, one theoretical and one practical.

First, the theoretical: US Treasury interest rates are set in the market, not by the Federal Reserve.  Like most prices (and an interest rate is a price), the rate emerges from the intersection of supply and demand.  The rate is not set by the Federal Reserve.  The Federal Reserve tries to influence rates through its monetary policy, but it does not set rates.  If the Federal Reserve lowers its rates but the fundamental supply and demand in the marketplace does not change, neither will Treasury rates.  It’d be like pushing on a rope: no matter how much you push, it’ll just coil in on itself.

Indeed, if the market believes the Federal Reserve rate cuts are unjustified, likely causing inflation, the market may demand higher interest rates to compensate for the expected inflation.  Thus, arbitrarily lowering Federal Reserve rates could actually lead to higher borrowing costs for the Federal government.

We have seen this behavior in the US before.  For example, in the period 2003–2004, the Federal Reserve target rate was falling/flat, and Treasury interest rates were generally rising.  In the period 2008–2015, the Federal Reserve target rate was flat—close to zero—and Treasury interest rates did their own thing: sometimes rising, sometimes falling, sometimes being flat.  Most recently, Treasuries started to rise in August 2020, a full year and a half before the Federal Reserve started raising rates.  And Treasury rates continued to rise even as the Fed began cutting rates in 2024.

Second, the practical: Current projections of the US federal budget and debt indicate that debt will continue to grow if nothing changes.  Consequently, this suggests that the Federal Government will need to issue more Treasuries to fund the debt.  That suggests an increasing supply curve.  If the supply curve increases, all else held equal, the price of a commodity falls.  Since the price of a bond and its interest rate are inverses, the increase in Treasury supply indicates a rising interest rate, thus leading to higher borrowing costs.

Ultimately, it is only good economic sense, not wishful thinking, that will lead to lower borrowing costs in the US.