Rising budget deficits trigger a vicious circle. They increase the federal debt, so interest expenses on the debt go up, making the deficit balloon even more. As recently as last year, the Congressional Budget Office was projecting increases in the federal debt--and in interest expenses--as far out as it could see, namely until 2007. But with the ink in the federal budget turning from red to black, the budget office sees the vicious circle changing into a virtuous one--a shrinking debt will mean steadily dropping interest payments, which will help cut the debt and make interest payments even smaller.
In fact, interest expenses could decline from 15% of the federal budget now to just 8% by 2008, according to the CBO. The result would be higher domestic investment, reduced current-account deficits, or both, says Prudential Securities Inc. Chief Economist Richard D. Rippe. And although the CBO assumes stable interest rates, Rippe says rates should fall--taking yet another bite out of debt-service costs.