Federal Reserve chair Jerome Powell once again warned earlier this month thatthe U.S. government’s fiscal policy is on an unsustainable path.
His new warning came at a forum held by the European Central Bank in Sintra, Portugal, on July 2, 2024. TheFinancial Times’sMartin Arnoldreports:
"Jay Powell warned that the Biden administration was taking excessive risks by “running a very large deficit at a time when we are at full employment” and said “you can’t run these levels in good economic times for very long”."
It’s not the first time Jerome Powell has issued such a warning. Theprevious warningwas in October 2023. However, unlike then, Powell’s new comments made a distinction: “The level of debt we have is completely sustainable, but the path we are on is unsustainable.”
On July 2, the U.S. government’stotal public debt outstandingstood at $34.87 trillion, which is a very big number. If that level of debt is sustainable, as Powell claims, how is the path the U.S. government on unsustainable? How can both things be true at the same time?
The answer to that question has everything to do withinterest ratesand the U.S. government’sexcessive spending.
Because of its excessive spending, the U.S. government is not able to fully retire its debt as it comes due and reduce the total amount. Instead, it has to borrow even more to cover its new spending. It must also roll over debt for money it has previously borrowed and cannot fully pay off. Worse, it is doing all that at today’s interest rates, which are higher than whenthe debt being rolled over was borrowed.
What makes that problem unsustainable is that excessivefederal government spendingcontributesto inflation.The inflation unleashed by U.S. politicians in recent years forced the Fed to respond by hiking interest rates to get it back under control. Today’s modestly elevated interest rates make today’s excessive spending unsustainable.
Ifexcessive government spending were broughtunder control, however, it would make the Fed’s job of fighting inflation easier. Interest rates could come down, which, if they did, would make it more possible to sustain such a large national debt. That’s the point Powell was making.
The only problem is that few in Washington DC are interested in reining in the U.S. government’s excessive spending. Until they do, the U.S. government’s fiscal policies will remain unsustainable.
