Inflation And The Macroeconomic Trap Of Fiscal Dominance
Bloomberg recently published an article by Noah Smith titled “Two Big Things You Need To Understand About Inflation.” The article describes the “macroeconomic trap” known as “fiscal dominance”, or when fiscal policy dominates monetary policy.
Smith explains that the current low interest rates allow the government to avoid paying large interest payments on government debt, which is currently about $21.7 trillion, or just over 100% of GDP.
Smith opines even a modest rate hike enacted by the Federal Reserve could send interest rates soaring and “If government interest payments go too high, the U.S. would have to either hike taxes, cut spending or borrow even more to cover the greater interest costs. If the government, fearful of a recession, chooses the “even more deficits” option, that could raise inflation even more and force the Fed to hike rates yet again.”
“Eventually this process would lead to some sort of bad end — either Congress would finally capitulate and enact a punishing austerity program, or borrowing would continue and inflation would spiral out of control, or the government would decide to default on its debts. The austerity option would be the least bad, but any of these would be extremely painful for American workers and consumers.”
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Smith, N (2021, May 11) “Two Things You Need To Understand About Inflation.” Retrieved from: https://www.bloomberg.com/opinion/articles/2021-05-11/debt-makes-the-fed-s-job-harder-if-inflation-accelerates
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