My boss, Andrew Stuttaford, writes that the Federal Reserve is slouching toward fiscal dominance, a condition in which monetary policy is made subservient to fiscal policy to help service an unmanageable national debt, even at the expense of controlling inflation. I believe we’re already there.
Fiscal dominance usually refers to the manipulation of interest rates to reduce the cost of servicing the national debt. By artificially lowering rates, the government can borrow and refinance its debt more cheaply than if the Fed set rates where the market would have them. Because cheaper borrowing leads to an expansion of credit, and thus the money supply, too-low interest rates are also inflationary. This is the mechanism by which Andrew thinks the Fed may abandon its duty of price stability to keep the government from defaulting on its debts catastrophically.
There is another mechanism of fiscal dominance, however, and it is even more blatant: debt monetization. This occurs when a central bank purchases newly issued debt from the government. Instead of borrowing money from the American public, which simply moves existing money around the economy, the government would borrow from the Fed, which creates new money out of thin air. Monetizing the debt is, arguably, even more inflationary than artificially lowering interest rates, as rate cuts only affect the total supply of money indirectly if they induce new borrowing. Debt monetization, by contrast, involves the Fed injecting new money directly into the financial system.
And the Fed is already doing it. Trillions of dollars of U.S. national debt has already been monetized, causing the highest inflation in four decades, and the government expects the Fed to monetize trillions more indefinitely as the debt grows.
The Fed plays a tricky game to disguise its debt monetization. It never purchases bonds directly from the Treasury. Instead, it lets the Treasury first issue bonds to large financial institutions. Then, in a completely unrelated transaction (wink, wink), the Fed buys Treasury bonds from those same institutions in what are called “open market operations.” When the Fed’s bond purchases are especially large, such as after the 2008 financial crisis or during the Covid-19 pandemic, that’s called “quantitative easing.”
Periods of quantitative easing just happen to coincide with periods of enormous federal debt issuance, typically to finance responses to recessions. Between the first quarter of 2020 and the second quarter of 2022, the government borrowed over $7 trillion to fund multiple pandemic-era spending packages. Over the same period of time, the Fed absorbed $3.25 trillion in Treasury bonds — more than doubling its holdings of federal debt in just over two years. In effect, nearly half of the debt the government issued ended up on the Fed’s balance sheet.
But, defenders will respond, the alignment of the Fed’s monetary expansion and the government’s fiscal stimulus was merely coincidental. They shared a common cause — the pandemic — but the former did not exist to enable the latter. Both efforts aimed at preventing economic collapse during extraordinary circumstances. Quantitative easing was intended to prop up financial markets and stimulate private lending, not to finance the national deficit.
Perhaps. But regardless of intent, the Fed did effectively monetize the deficit through its bond purchases. Inflation was the inevitable (and predicted) consequence.
Even more damning than the Fed’s past actions, however, is what the Fed is expected to do in the future: It is the government’s official projection that the Federal Reserve will purchase trillions of dollars in federal debt over the coming years with no end in sight.
The Congressional Budget Office, a federal agency within the legislative branch, publishes an annual forecast of the nation’s finances over the next decade. It assumes an economic baseline — no recessions, no wars, no crises, and, least realistically, no new government programs. In January of 2025, the CBO projected that publicly held national debt would grow from $30 trillion this year to $52 trillion in 2035, or from 97.8 percent of the U.S. economy to 118.5 percent. (These figures should already be revised even higher, as the reconciliation bill that Republicans passed earlier this year is expected to increase the debt by another $3.4 trillion, plus interest costs.)
Equally terrifying is the CBO’s breakdown of who will own that additional $22 trillion in debt. The agency projects that the Federal Reserve’s ownership of publicly held national debt will grow every year from 2025 onward, from just over $4 trillion this year to nearly $10 trillion by 2035. That increase of $6 trillion wouldn’t happen automatically. It could only come about if the Fed chooses to purchase more federal debt than it ever has before — an unprecedented monetary expansion, with zero recessions assumed.
Remember, that is the government’s expectation. It’s an incredible admission: For the government to finance its looming debt obligations, the Federal Reserve is going to have to pick up a huge chunk of the bill indefinitely, as a matter of course. Debt monetization forever.
If the Fed has to keep monetary policy exceptionally loose to finance the debt, regardless of economic conditions, it will necessarily have to surrender to persistent inflation. Indeed, that is what it already seems to be doing — but things can get much worse than the 3 percent inflation we have now. According to the government’s own projections, we’ll see soon enough.