Are Fiscal Folly and Money Mischief Our New Normal?

It didn’t take long for everyone to realize President Trump’s “big, beautiful bill” is a budget buster. As written, it will add $3 trillion to the national debt over the next 10 years. Policy wonks are worried about the national government’s fiscal integrity. I am, too—but I’m more worried about the independence of the Federal Reserve. It’s not easy to conduct monetary policy when fiscal policy is perpetually reckless.

The U.S. national debt is more than $30 trillion, which is about the value of all newly produced goods and services in a year. Moody’s recently downgraded the federal government’s credit rating because of mounting debt and debt-service costs. Sooner or later, bond vigilantes from around the globe will come for us. Government debt yields will rise as investors become skittish. And when that happens, the Fed will be in a very tricky spot.

While the Fed is not totally independent—Congres rightly sets its goals and approves its top personnel—fiscal policymakers should not pressure monetary policymakers to make borrowing easier. But it’s hard to see how we can avoid this given our fiscal trajectory. Economists call this sad state of affairs “fiscal dominance”: monetary policy can’t achieve stable prices and moderate interest rates when it’s subordinate to fiscal-policy demands for cheaper financing.

Central banks can lower government borrowing costs in the short run by purchasing government debt. This raises bond prices and lowers yields. The inevitable long-run result is inflation. Dollar depreciation means higher prices all across the economy, including interest rates, which are prices for rented capital. If the central bank purchases the debt with newly circulating money, inflation will follow as surely as night follows day.

But politicians care about the short run—anything beyond the next election is a luxury they can’t afford. Spending is popular, but taxes are not, so they turn to printing-press finance. Politicians will paper over chronic deficits if it helps them postpone the pain.

We might not have to wait for fiscal dominance over the Fed. Voluntary monetary submission has already happened. COVID-19 created an awful precedent we have not fully grappled with.

Government spending skyrocketed during the pandemic. So did borrowing. What matters is how the Fed supported it: between 2020 and 2022, the Fed’s balance sheet grew from $4.2 trillion to $8.9 trillion. Approximately $3.1 trillion was from government-bond purchases, two-thirds of the total. The Fed’s July 2021 meeting minutes state that the expansion was undertaken to “smooth financial market functioning and [promote] accommodative financial conditions.” Given the importance of Treasuries in the financial system, this obviously included the market for government debt. Economist John Cochrane, arguably the leading expert on how the government’s fiscal trajectory affects the cost of living, noted that the Fed “immediately bought new Treasury debt with newly created money” essentially as a program to finance spending.

Fed officials were aware of massive increases in spending and debt, and knew their asset purchases would mute the effect on borrowing costs, including Treasury yields. This was monetary accommodation of fiscal profligacy, plain and simple.

Everyone knows that these policies sparked inflation. Consumer prices rose at the fastest rate in 40 years. Inflation peaked at 9 percent in summer 2022. The Fed eventually reversed course and tightened monetary policy. Chairman Powell deserves credit for staying strong in the face of President Trump’s obvious displeasure. But we wouldn’t have suffered through crippling dollar depreciation, and we wouldn’t be staring at a possible constitutional crisis, had the central bankers not bent the knee in the first place.

There is no escaping the government’s basic budgetary reality. To spend, it must tax, borrow, or print. Option one gets politicians thrown out of office. Option two remains attractive only if lenders are willing to play ball. That leaves option three—and the Fed has already proven it’s not repulsed by the idea. So much the worse for all of us. The Fed can help Uncle Sam pay its bills or it can promote economic stability. It cannot do both. When push comes to shove, I’m increasingly skeptical it will make the right choice.