Maybe there just needs to be someone in Washington with some credibility who can speak up and say the deficit needs to be reined in.
After every Federal Open Market Committee meeting, the committee puts out a statement on monetary policy. The statement has consistently (and correctly) said that the Fed remains committed to pushing inflation back down to its 2 percent long-run target. For months, that statement mentioned stressors contributing to inflation such as supply-chain problems and the war in Ukraine. Perhaps understandably, the Fed did not acknowledge its own role in contributing to inflation by pursuing an overly expansionary monetary policy for too long.
Now, though, there’s another contributor to inflation that is making the Fed’s job more difficult than it needs to be: the federal deficit. It doubled this year to $2 trillion despite low unemployment, the conclusion of the pandemic, and no major new domestic programs or wars. Politicians are essentially promising to do nothing about it by refusing to countenance entitlement reform, and for once they’re keeping their word. Borrowing costs continue to increase as the bond market slowly loses confidence in the government’s ability to pay them back in full.
This all directly relates to the Fed’s mandate from Congress to keep prices stable. Fiscal policy is working at cross purposes with monetary policy, and it has been for some time now. The Fed raises interest rates to quell inflation, which then makes borrowing more expensive.
The response from Congress should be to borrow less and therefore spend less, but fiscal policy shows no signs of tightening any time soon. The deficit spending puts further pressure on inflation, which the Fed counteracts with higher interest rates per its mandate for price stability, which then leads to higher borrowing costs for the government and crowds out private borrowing and investment. It’s a vicious cycle that will make the U.S. economy worse.
The Fed would be overstepping if it said how the budget should be written or how entitlements should be reformed. The Fed is supposed to be independent of politics, and it should be. Budgeting is a job for Congress under the Constitution.
The Fed would not be overstepping, though, to simply say that the deficit is too high and should be reduced. It would not be difficult to explain that the overdone government spending is making the Fed’s mandate for price stability more difficult to accomplish. It would not need to be partisan in any way, since both parties have run up the debt.
There is no school of economic thought (MMT doesn’t count) that says the government should run a massive deficit in a time when unemployment is below 4 percent, with no major wars or domestic emergencies. Current U.S. fiscal policy is indefensible, regardless of partisanship. It would be one thing if the negative effects weren’t yet manifesting themselves, but the surge in inflation and the increase in borrowing costs are hurting Americans.
“We don’t comment on fiscal policy,” Jerome Powell recently said, but as Greg Ip points out in the Wall Street Journal, that isn’t true. In April 2020, Powell said, “This is the time to use the great fiscal power of the United States to do what we can to support the economy.” He repeatedly encouraged Congress to pass a large fiscal stimulus, which it did with the CARES Act.
“Powell kept up his support through fall 2020,” Ip writes. “And while he didn’t explicitly back President Biden’s $1.9 trillion American Rescue Plan in early 2021, he did play down concern that inflation could result.”
Ip correctly notes that “the Fed should put its reputation on the line only if it has any chance of accomplishing something.” If Congress is truly unwilling to listen to anything the Fed says and would seek retaliation for any questioning of its fiscal policy, it wouldn’t be worthwhile for the Fed to speak up. That does seem to be the case right now.
But maybe there just needs to be someone in Washington with some credibility who can speak up and say the deficit needs to be reined in. Perhaps it’s a first-mover problem, where once someone with some authority on economic policy acknowledges the problem, others will follow. The emperor has no clothes right now. Maybe Powell could be the one to point it out.