Since the onset of the Covid-19 pandemic, the Fed’s excessive money creation has been a major driver of inflation. Prices across the economy have surged, reducing the dollar’s purchasing power. The most popular measure of inflation is the consumer price index. It’s up 7.5 percent year-over-year. The Fed’s preferred measure, called the personal consumption expenditures price index, has risen at 5.8 percent year-over-year. Both are 40-year highs.
The Fed is in the driver’s seat, but Congress is riding shotgun. Deficits indirectly contribute to inflation. Since January 2020, the national debt has increased by nearly $6 trillion, crossing the $30 trillion mark for the first time. Much of this debt was monetized by the Fed. Central banks can’t resist underwriting fiscal ineptitude.
Congress’s prodigal spending forces us to confront some uncomfortable truths about debt. The 2021 interest payment on the national debt was $562 billion. And that’s with historically low interest rates. If borrowing costs start to rise, merely servicing the debt will consume an ever-larger share of the federal budget. We’re already on track for debt to exceed 200 percent of GDP over the next generation. Even moderately higher interest rates could crowd out important federal programs.
Broken fiscal and monetary policies are part of a single pathology. We need to tackle them both.
Almost 250 years ago, Adam Smith wrote about the juggling trick of deficits, debts, and monetary debasement. Governments spend beyond their means to please existing constituencies at the expense of future generations. The national debt creeps ever upward. To lessen the debt burden, governments run the printing press, creating new money instead of enacting unpopular spending cuts or tax hikes. The inevitable result is inflation, which hits ordinary families the hardest.
These days, too many making policy recommendations dress them up in the technical language of academic economics. Yet doing so doesn’t make them fundamentally better, as fiscal and monetary prodigality are still economically destructive. Instead of papering over Congress’ irresponsible fiscal profligacy, it should be leading the world in practicing responsible fiscal prudence.
On fiscal policy, we need to keep spending growth below economic growth. Doing so would ensure that the tax base keeps pace with demands on the public purse. If we follow this rule, debt as a share of GDP will fall over time. We don’t need to necessarily balance the budget right away to get back to a sustainable fiscal trajectory. Except during a national emergency, such as the early part of the pandemic, it should be much harder for Congress to ratchet up spending.
On the monetary side, we need to narrow the Fed’s mandate to price stability alone and impose penalties when central bankers goof. Monetary policymakers can’t achieve full employment except by keeping the dollar’s purchasing power predictable, so there’s no need for an employment component in the mandate. Repeated bungling by Fed officials should come with professional consequences.
Policymakers’ incentives often diverge from the public interest. That’s why constraining them with rules and holding them accountable for their excesses is essential. We’ve learned the hard way we must reform fiscal and monetary policy at the same time. Unless we solve both problems, the ship of state will continue taking on water faster than we can bail it out.