Shifting expectations of the Federal Reserve raising interest rates on Wednesday is intended to tame inflation, but could have other side effects – including a possible recession. It turns out that rising rates could explode the federal deficit even further in the coming years.
A new analysis from the budget hawks at the Committee for a Responsible Federal Budget (CRFB) predicts that this week’s expected rate hike of three-quarters of a percentage point will — by itself — add $2.1 trillion to government deficits over the next decade.
That’s on top of a series of increases we’ve already seen this year that have already added an extra trillion in costs. The central bank is wrapping up its two-day policy meeting on Wednesday and more rate hikes are likely in the coming months.
To be sure, the impact of the deficit is far from the most pressing concern of inflation-oriented policymakers. Yet it is a significant factor that is likely to challenge the Federal Reserve and fiscal policymakers as they try to navigate a “soft landing” that will reduce the inflation rate without triggering a recession.
“The irresponsible fiscal policy [of recent years] The Federal Reserve’s job has become more difficult again,” said Maya McAnghusa, president of the CRFB, to Yahoo Finance this week.
The national debt — the total amount of money owed by the US government — is nearly $31 trillion. Meanwhile, the US has an annual budget deficit of $1 trillion, which is the amount of money the US needs to borrow each year to pay for its expenses. Interest payments on the debt itself are expected to be the fastest growing part of the federal budget in the coming years.
“It’s like they’re now walking two different tightropes at the same time,” MacAngus says of the Federal Reserve’s challenges in curbing inflation without further fueling the debt.
A range of other economists this week on Yahoo Finance weighed in on the chances of the economy softening on the eve of the Fed’s latest decision. Vanguard Senior International Economist Andrew Patterson said Tuesday that it may be difficult to avoid a Fed-induced recession in 2023 but that the coming downturn is likely to be “data-driven, somewhat milder in nature.” “
Shawn Snyder, Head of Investment Strategy at Citi US Wealth Management, said that if the economy sees signs of a recession, such as consecutive monthly job losses, in the coming months it could put the Fed “in a tougher spot, and I think that will put them in. maybe a holding pattern.”
The federal funds rate and the national debt
In the early 1980s, the charge against inflation was led by Federal Reserve Chairman Paul Volcker. Although the central bank’s benchmark interest rate rose to the teens at the time, Volcker had an advantage because the government debt at the time was only about 30% of GDP.
Today, total debt has risen to around 120% of GDP.
On Wednesday, officials are expected to raise the federal funds rate to a range of 3.0% to 3.25% as part of an effort to reduce inflation from the current level of 8.3%. The move would mark the third straight 75-basis-point rate hike since June and take rates to their highest level since 2008.
In June, the CRFB analyzed the rate hikes up to that point and projected that annual interest costs will triple by 2032, up from nearly $400 billion now to $1.2 trillion over the next decade. Total costs are projected to be $8.1 trillion over the next decade. “In reality, however, interest rates – and subsequently interest costs – could be even higher,” the authors said.
Economic observers will be watching closely for clues from the Fed about how high it will raise interest rates in the coming months, from comments by current Chairman Jerome Powell or when the Fed releases a summary of interest rate expectations known as the ” dotted dot”.
‘Two extremely reckless periods of excess lending’
Speaking to Yahoo Finance, MacAnghusa blamed the debt situation on the gluttony of lawyers in both parties. She recognized the importance of spending trillions to fight COVID. But, she said, “That was between two very reckless periods of excessive borrowing when we shouldn’t have been.”
Both the Tax Cuts and Jobs Act of 2017 signed by then-President Trump and later spending by the Biden administration have driven record deficits, she said. Her group recently criticized Biden’s executive order to forgive student loans, projecting that it will add about half a trillion dollars to already sky-high deficits.
In recent years, policymakers in both parties have played down concerns about debt. Republicans have long argued that the 2017 tax cuts would pay for themselves, though that has not been proven. Democrats, meanwhile, argue that deficits don’t matter; some cite the incorrect economic principle known as Modern Monetary Theory, which posits that the government can avoid the consequences of debt because it can print more money.
“All these arguments trick politicians into believing that they don’t have to pay for things,” MacAnghus said. These theories, she said, have given “politicians eager to grab a pass.”
Ben Werschkul is the Washington correspondent for Yahoo Finance.
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