Last week, Moody downgraded the United States’ credit rating from Aaa, the highest possible rating, to Aa1, the last of the big three credit rating agencies to do so. This decision is reflective of worry among institutions regarding longstanding U.S. policies, with Moody writing that its decision “reflects the increase over more than a decade in government debt and interest payment ratios.” 

The Daily Illini talked to professor in LAS Greg Howard about credit ratings, rising American debt and interest rates. Howard is a professor in the Economics department who teaches classes in macroeconomics. Here are some of the key ideas he talked about.

Credit Ratings

Credit ratings evaluate the likelihood of a borrower repaying debt. One might be familiar with individual credit scores such as the FICO score. However, sovereign credit ratings look at the trustworthiness of entire countries and their ability to repay debts. Howard said that Moody’s downgrade of the U.S. is mostly symbolic.

“What it symbolizes is pretty important,” Howard said. “The purpose of the rating agencies is to just give information to market participants about the grand worthiness of borrowers … But I think what it symbolizes is that there’s a general decrease in the perceived trustworthiness of the U.S. government to repay its debt, largely because the national debt has been growing for a long time.”

The U.S. is over $36 trillion in debt. This is only expected to increase, as Moody wrote in its report that it expects “larger deficits as entitlement spending rises while government revenue remains broadly flat.” 

Howard emphasized that, while the change may seem subtle, it carries important implications.

“They’re not saying that it’s likely that the U.S. is going to default, but I think it’s certainly recognizing the challenges and at least a possibility that they would default, which has historically not been something that I think anyone was worried about,” Howard said.

If the U.S. were to default on its debt obligations — a situation which has never happened in American history — the negative repercussions would be “catastrophic,” according to the Treasury Department. Howard expanded on the consequences of default.

“The only thing I emphasize in my class is that financial crises of any sort, including kind of sovereign defaults, are typically extremely costly,” Howard said. “You end up with very large declines in GDP and output that is kind of permanently on a lower trend than it was before. Even small changes in the profitability of defaults are things to be concerned about. That’s kind of what is represented by this downgrade.”

Debt and deficits

When the U.S. spends more money in a fiscal year than it makes, it incurs a deficit that it resolves by borrowing money through selling bonds and other securities. As the federal government continues running up deficits, the national debt grows. 

A useful metric to consider is the ratio between a country’s debt and its gross domestic product. According to the Treasury Department, this ratio “is considered a better indicator of a country’s fiscal situation because it shows the burden of debt relative to the country’s total economic output and therefore its ability to repay it.”

Howard commented on the U.S.’s ratio, which in 2024 was 123%.

“I don’t think the optimal is zero — there’s clearly a lot of international demand for U.S. assets that are perceived to be safe and provide liquidity for banking systems and things like that,” Howard said. “But you don’t want it to be as high as it is now.”

Howard added that there could be exceptions. Japan has a higher ratio than the U.S., which Howard says has historically not been a huge issue because of low interest rates. However, on Wednesday, yields on Japanese bonds rose to all-time highs due to low demand. Howard says “there’s no magic number” when it comes to the ratio.

As debt increases, so do interest payments. In 2024, the U.S. spent over $1 trillion on interest expenses for its outstanding debt, which could become a problem down the road.

“(Large deficits) run the risk of someday not being able to borrow more,” Howard said. “It constrains spending in the future … so more tax dollars are going to paying interest, rather than for useful purposes.”

Interest Rates

Theoretically, as the U.S. becomes a riskier borrower, the interest rates on treasury securities such as bonds increase. When Moody downgraded the U.S.’s credit rating, this was realized in the bond market. 

“30-year bond rates are reasonably high right now,” Howard said. “If you were trying to get a mortgage, it’s more expensive than it would have been a few months ago because investors are charging the U.S. more interest in order to borrow.”

After Moody’s downgrade, the 30-year bond rate reached 5%, the highest since November 2023, and the 10-year note’s yield also increased. The 30-year mortgage rate is closely tied to the 10-year treasury note, so when the 10-year note’s yield increases, borrowing becomes more expensive. This leads to increased mortgage monthly payments and could also extend to student loans. 

“Either directly or indirectly, (student loans) would be affected,” Howard said. “Many existing student loans are fixed-rate, but new student loans will have to pay higher interest rates for sure.”

Howard says higher student loan interest rates could have consequences for university enrollment. 

“Interest rates kind of directly affect the demand for college,” Howard said. “If you have to take loans out at a higher interest rate, then people that are on the margin of going to college are going to choose not to do that because the return would need to be even higher to pay back the interest.”

Politics

Macroeconomic conditions in the U.S. are impacted by fiscal policy, which is why Moody pointed the finger at “successive U.S. administrations and Congress” for large deficit spending. Howard made clear that while these issues are inherently political, there are real tradeoffs to reducing government spending.

“If it weren’t for political constraints, it would not be hard for the U.S. to raise taxes or cut spending in such a way that we did not have to worry about default at all,” Howard said. “On the other hand … cutting government spending and raising taxes is generally not only unpopular but unpopular for a reason. That is money that would otherwise be going to productive things.”

Howard pointed out that political incentives often create a mismatch between who makes fiscal decisions and who bears their consequences.

“There’s a temptation for policymakers to be much more focused on the short term than the long term,” Howard said. “That’s one of the reasons it’s hard for countries around the world, including the U.S., to have very much fiscal discipline. The costs are something that will occur down the road, often after policymakers are out of office, whereas the benefits of spending are accruing now.”

The Trump administration attempted to cut wasteful spending by creating the Department of Government Efficiency via executive order. DOGE claims to have saved $175 billion. Critics of DOGE, however, point to accounting errors and miscalculations. They also raise concerns about the full cost of DOGE, with one analysis estimating the total at $135 billion.

White House spokesperson Harrison Fields pushed back against those criticisms.

“The continued attempts to sow doubt in the massive accomplishments of this never-before-seen effort to make government more efficient speaks more about the illegitimacy of those peddling these falsehoods than good work of DOGE,” Fields said in a statement to Fortune. 

Ultimately, Howard says that there’s no “magic way to fix” the issue of rising debt, but maintains that the problem should not be ignored.

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