By hiking interest rates, the Federal Reserve has pulled some of its monetary stimulus out of the economy. While the Fed hasn’t done nearly enough to put the inflationary fire it lit with more than a decade of easy money, cooling consumer price index (CPI) indicates that this has put a modest dent in price inflation — for now. But the federal government has opened the fiscal stimulus spigot even wider and government spending is mucking up the inflation fight. In fact, unless the federal government reins in spending, there is no way inflation will lose this fight.
And that’s not going to happen.
In just the first six months of fiscal 2023, the U.S. government ran a $1.1 trillion budget deficit.
To put that into perspective, the Obama administration ran its biggest deficit in 2009 during the depth of the Great Recession. That was a mere $1.4 trillion – in an entire year.
Ironically, President Joe Biden keeps bragging about how his team has lowered the deficit. But that’s just because he’s comparing it to the massive $3.1 trillion deficit the government ran in 2020 during the pandemic. In fiscal 2022, the Biden administration piled up a $1.3 trillion budget shortfall despite strong receipts to the U.S. Treasury. That was bigger than three of the four largest deficits Obama ran during the stimulus years after the Great Recession.
This is not to let Republicans off the hook.
During the 2016 presidential campaign, Trump promised to deal with the skyrocketing national debt. In fact, he said he could take care of it “fairly quickly.” But during his four years in office, he didn’t even pay lip service to reining in spending, instead, approving bigger outlays for both military and domestic spending.
Most people blame the coronavirus for the surging deficits in the final years of Trump’s presidency. Pandemic-related spending certainly exacerbated the situation, but Uncle Sam had a spending problem long before the coronavirus reared its ugly head. In FY2019, the Trump administration ran a $984 billion deficit. At the time, it was the fifth-largest deficit in history. Through the first two months of fiscal 2020, the deficit was already 12 percent over 2019’s huge Obama-like number and was on track to eclipse $1 trillion.
The bottom line is the U.S. government has a spending problem no matter who is sitting in the Oval Office.
The March 2023 Deficit
According to the latest U.S. Treasury report, the March budget deficit came in at just over $378 billion. Other than last September when the Treasury recognized some of the cost of Biden’s student loan bailout, it was the largest deficit month since March 2021 when Biden signed the last COVID bailout package.
The problem is the U.S. government faces a double-whammy of falling receipts and increasing spending. Through the first six months of fiscal 2023, tax receipts and other federal revenues are down 3.5 percent while spending is up 12.9 percent.
There has clearly been a shift in federal receipts. The federal government enjoyed a revenue windfall in fiscal 2022. According to a Tax Foundation analysis of Congressional Budget Office data, federal tax collections were up 21 percent. Tax collections also came in at a multi-decade high of 19.6 percent as a share of GDP. But CBO analysts warned it won’t last. And government tax revenue will decline even faster if the economy spins into a recession.
But the real problem is on the spending side of the ledger. The Biden administration is blowing through roughly a half-trillion dollars every single month. In March alone, the U.S. government spent $691.3 billion.
And there is no indication that the spending freight train will slow down any time soon. Congress passed a $1.7 trillion omnibus spending bill for 2023 that increased outlays by about $1.5 billion over fiscal 2022.
Of course, this is only one component of federal expenditures. The U.S. government is still handing out COVID stimulus money, and in March 2021, Congress approved $1.9 trillion in spending to address the pandemic. Last year, it passed the euphemistically named “Inflation Reduction Act.” Meanwhile, the U.S. continues to shower money on Ukraine and other countries around the world. All of that spending will pile on top of this most recent allocation of funding.
Meanwhile, the Federal Reserve raised interest rates by another 25 basis points in March. That will add to the quickly ballooning interest cost.
According to an analysis by the New York Times, net interest costs rose by 41 percent in 2022. According to the Peterson Foundation, the jump in interest expense was larger than the biggest increase in interest costs in any single fiscal year, dating back to 1962.
The U.S. government has already spent over $300 billion servicing the interest on the national debt in fiscal 2023. At this rate, interest expense alone will cost Uncle Sam in the neighborhood of $600 billion this fiscal year. If interest rates remain elevated or continue rising, interest expenses could climb rapidly into the top three federal expenses. (You can read a more in-depth analysis of the national debt HERE.)
Mucking Up the Inflation Fight
This massive level of government spending creates two big problems for the Federal Reserve in its battle against price inflation.
In the first place, higher interest rates mean higher borrowing costs for the government. As already discussed, the trajectory of interest payments already looks unsustainable over the long term. Unless it cuts spending, the federal government will need interest rates to come down in order to borrow money cheaply and sustain its spending levels.
In the second place, the Fed will end up having to monetize at least some of this debt.
The only reason the U.S. government can borrow and spend to the extent that it does is because the Fed keeps its big fat thumb on the bond market. The federal government needs the central bank to buy Treasuries to prop up demand. Without the Fed’s intervention in the bond market, prices will tank, driving interest rates on U.S. debt even higher. But debt monetization means money creation. The Fed buys Treasuries with money created out of thin air. This is – by definition – inflation.
Right now, the Fed gets a little wiggle room because the US government has run up against the debt ceiling. It can’t borrow money right now, and it’s currently running “extraordinary measures” to fund government spending But as soon as the fake debt ceiling fight ends, the US Treasury will need to sell a large number of bonds to catch up to the ballooning deficit.
This isn’t merely speculation on my part. A paper published by the Kansas City Federal Reserve Bank acknowledged that the central bank can’t slay inflation unless the US government gets its spending under control. In a nutshell, the authors argue that the Fed can’t control inflation alone. U.S. government fiscal policy contributes to inflationary pressure and makes it impossible for the Fed to do its job.
Trend inflation is fully controlled by the monetary authority only when public debt can be successfully stabilized by credible future fiscal plans. When the fiscal authority is not perceived as fully responsible for covering the existing fiscal imbalances, the private sector expects that inflation will rise to ensure sustainability of national debt. As a result, a large fiscal imbalance combined with a weakening fiscal credibility may lead trend inflation to drift away from the long-run target chosen by the monetary authority.”
This clearly isn’t in the cards.
Something has to give. The Fed can’t simultaneously fight inflation and prop up Uncle Sam’s spending spree. Either the government will have to cut spending or the Fed will eventually have to go back to creating money out of thin air in order to monetize the debt.
You can decide which is more likely.
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