The Federal Reserve’s widely anticipated move to raise interest rates on Wednesday aims to tame inflation, but could have other side effects, including a possible recession. It turns out that a rate hike could also cause federal deficits to explode further in the years to come.
A new budget hawks analysis by the Committee on Responsible Federal Budgeting (CRFB) predicts that this week’s projected rate hike by three-quarters of a percentage point will, on its own, add $ 2.1 trillion to government deficits in the year. next decade.
This is in addition to a number of increases we have already seen this year that have already added trillions of extra costs. The central bank is wrapping up its two-day policy meeting on Wednesday with further rate hikes likely in the coming months.
To be sure, the deficit impact is far from the most pressing concern for inflation-focused policymakers. However, it is a significant factor that could challenge the Federal Reserve and fiscal policymakers as they try to deal with a “soft landing” that lowers the rate of inflation without triggering a recession.
“Irresponsible fiscal policy” [of recent years] it has made the Federal Reserve’s job many times more difficult, “Maya MacGuineas, president of the CRFB, told Yahoo Finance this week. This challenge, he added,” makes the possibility of a recession even more likely. “
The national debt – the total amount of money owed by the US government – amounts to nearly $ 31 trillion. Meanwhile, the United States has an annual budget deficit of $ 1 trillion, which is the amount of money the United States has to borrow each year to pay for its expenses. The interest payments on the debt itself are expected to be the fastest growing part of the federal budget in the years to come.
“It’s as if they are now walking on two different tight ropes at the same time,” MacGuineas says of the Federal Reserve’s challenges to curb inflation without further inflaming debt.
A number of other economists this week assessed on Yahoo Finance the chances of a soft landing for the economy on the eve of the latest Fed decision. Vanguard senior economist Andrew Patterson said Tuesday that a Fed-induced recession it may be difficult to avoid in 2023, but the next recession “is, based on the data, probably a bit milder in nature.”
Shawn Snyder, Head of Investment Strategy at Citi US Wealth Management, added that if the economy sees signs of recession, such as the loss of consecutive monthly jobs, this could put the Fed “in a more difficult situation in the coming months. and I think it will put them into question a model of sealing “.
The federal funds rate and the public debt
In the early 1980s, then Federal Reserve Chairman Paul Volcker led the charge against inflation. While the central bank’s benchmark interest rate had skyrocketed at the time, Volcker had an advantage because public debt then made up 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 its current 8.3% level. The move would mark the third consecutive rate hike of 75 basis points since June and take rates to their highest level since 2008.
In June, the CRFB analyzed the rate hikes so far and predicted that annual interest costs would triple by 2032, rising from nearly $ 400 billion today to $ 1.2 trillion over the next decade. Total costs were projected to be $ 8.1 trillion over the next decade. “In reality, however, interest rates – and in turn interest costs – could be even higher,” the authors added.
Economic observers will be watching closely the Fed’s hints on how high interest rates will rise in the coming months, from comments by current President Jerome Powell or when the Fed releases a summary of interest rate expectations known as a “dot plot”.
“Two very reckless periods of excess debt”
Speaking to Yahoo Finance, MacGuineas blamed the debt situation for the spending binges of lawmakers on both sides. He recognized the importance of spending trillions of dollars spent on COVID. But, he added, “This was sandwiched between two very reckless periods of excessive lending when we shouldn’t have.”
The 2017 Tax Cuts and Jobs Act signed by then President Trump and the Biden administration’s most recent spending have both driven current record-breaking deficits, he said. His group recently criticized Biden’s executive order to forgive student loans, predicting it would add about half a trillion dollars to already high deficits.
In recent years, policy makers on both sides have downplayed debt concerns. Republicans have long argued that 2017 tax cuts would pay for themselves, even if they didn’t. Meanwhile, Democrats argue that deficits don’t matter; some cite the unorthodox economic principle known as Modern Monetary Theory, which postulates that the government can avoid the consequences of debt because it can print more money.
“All of these arguments lead politicians to believe they don’t have to pay for things,” MacGuineas said. These theories, he added, have “given a permit to politicians who are all too eager to grasp it.”
Ben Werschkul is a Washington correspondent for Yahoo Finance.
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