How the Fed’s Fight Against Inflation Ignites the National Debt

The Federal Reserve’s fight against inflation is adding fuel to the national debt as the central bank prepares to keep interest rates higher for longer.

Although inflation has plummeted since the Fed raised rates to a two-decade high last year, officials still aren’t comfortable with how quickly prices are rising. Fed officials hope to cut rates once before the end of the year, which would set the baseline borrowing range at 5% to 5.25%.

These higher interest rates from the Fed will also force the federal government to borrow money at a higher cost. Given that government spending is expected to increase over the next decade, the amount of interest the country pays on its multimillion-dollar debt is on track to surpass defense spending.

“It’s not the only factor, but it is a contributing factor to our deficits,” said Joseph Gagnon, senior fellow at the Peterson Institute for International Economics, in an interview.

“But the funny thing is… the big deficits are helping to force the Fed to keep interest rates high, because they just support a lot of spending,” he continued.

Recent numbers from the Congressional Budget Office (CBO) project that public debt, which amounts to more than $27 billion, will increase over the next decade relative to the size of the country’s economy, rising to more than 99 percent of gross domestic product. (GDP) in fiscal 2024 to 122 percent in 10 years.

While experts attribute much of the projected increase to spending, some also said the Fed’s fight against inflation is also adding to the situation.

“The government is spending a lot of money and is not taking taxes from people. So they’re still spending a lot, and that’s too much for the economy,” Gagnon said.

The Fed raised rates for the first time in 2022, after setting them near zero during the coronavirus pandemic – when government spending also increased as the government approved a significant amount of coronavirus relief – to help maintain the economy afloat.

The goal behind raising rates is to curb demand by discouraging consumers from taking out loans. Experts say loans can also be more expensive for the government, but that doesn’t mean it responds in the same way as consumers.

“It’s a little different than when you go to buy a car and say, well, the 10% interest rate is too high, I can’t buy this new car,” Gagnon said.

“If Congress passes a law that says we have to spend this much and the tax rate is x, then that doesn’t respond to interest rates, initially,” he said. “But if interest rates increase the deficit over time and Congress says, ‘Wait a minute, this deficit is too high,’ then maybe they will reduce the deficit.”

The CBO expects interest payments to reach $892 billion in 2024, exceeding annual defense spending, and eventually $1.7 billion in 2034, “at which point they would roughly equal projected Medicare spending.” , the report stated.

At the same time, however, the office notes that it expects the Fed to lower interest rates in its 2025 forecast, which some say underlines government spending.

“Debt interest costs are the product of interest rates and the amount of money the government is borrowing,” said David Wessel, senior fellow for economic studies at the Brookings Institution, in an interview. “And the biggest factor is the amount of money the government borrows, and that is the real reason why interest rates as a percentage of GDP are rising.”

“Obviously, as the Fed increases interest rates, short-term interest rates, it helps the bond market increase long-term interest rates, this makes loans more expensive. This is true,” he said. But he added: “The big factor is not what the Fed does.”

Another factor that federal analysts cite behind the country’s projected debt path is mandatory spending, especially as Social Security and Medicare costs are rising. The CBO estimates that, relative to GDP, spending on mandatory programs “will increase from 14.7% in 2024 to 15.3% in 2034.”

“Two underlying trends, the increase in the average age of the population (referred to as population aging) and the growth in federal health care costs per beneficiary, contribute to this increase,” the CBO said.

Budget hawks and experts pointed to the forecast as a warning to Washington, as both sides remain deeply divided over how to resolve the country’s deficits.

“I think it is highly dangerous. I think the fact that the interest cost of the debt, actually, as a percentage of GDP, hasn’t increased much for about 40 years, has given Congress an excuse not to resolve the debt,” said Eugene Steuerle, fellow member of the Richard B. Fisher, president of the Urban Institute, adding that “interest costs clearly increase the pressure on Congress to do something about the debt.”

Lawmakers on both sides are already looking ahead to 2025, when Congress will face another potentially nasty fight over the nation’s debt limit, which limits how much money the Treasury can owe to cover the nation’s bills.

Congress last lifted the debt ceiling in 2023, but only after a months-long, high-stakes partisan fight over spending. The national debt was then about $31 billion and has since risen to more than $34 billion.

“Eventually, Congress will do something. They can do it because there is some kind of crisis, they can do it because we have a leadership surge, and they can do it because we are getting to the point where the Social Security and Medicare trust funds are about to run out- if. of money,” said Wessel.

This story originally appeared on thehill.com read the full story