Introduction to the Problem
The national debt of the United States has been a pressing concern for many years, and it continues to grow at an alarming rate. Former Federal Reserve Chair Janet Yellen has warned that this mounting debt could cripple policymakers and limit their ability to address the country’s other fiscal challenges. Speaking at a panel on the "Future of the Fed," Yellen emphasized the risks associated with rising debt levels and the potential for "fiscal dominance" to take hold in the U.S.
What is Fiscal Dominance?
Fiscal dominance occurs when a central bank is pressured, implicitly or explicitly, to keep interest rates lower than warranted by macroeconomic conditions. This can happen when a government’s debt levels become so high that it is difficult for the central bank to raise interest rates without causing a significant increase in the government’s debt-servicing costs. Yellen warned that the preconditions for fiscal dominance are strengthening in the U.S., which could hamper the Fed’s ability to fulfill its central mandates of keeping prices stable and the labor market in good shape.
The Current State of the National Debt
The national debt of the United States has surpassed $38 trillion and is projected to reach $50 trillion and 118 percent of GDP within the next decade, according to estimates from the Congressional Budget Office (CBO). This rapid growth in debt is expected to lead to a significant increase in debt servicing costs, which could outstrip other forms of spending and increase future borrowing needs. As a result, the risk of a "fiscal dominance" scenario is rising, where central bank policymakers are forced to keep rates low to lighten the government’s debt burden.
The Impact on the Fed’s Ability to Fulfill its Mandates
A shift toward fiscal dominance would limit the Fed’s ability to manage inflation and keep the economy operating at full employment. With inflation still above the Fed’s long-term target of 2 percent and the labor market contending with slow jobs growth and unemployment at a four-year high, autonomy to address these issues is especially critical. Yellen emphasized that avoiding fiscal dominance has been a central objective of modern central banking frameworks and that the potential for fiscal dominance should be a concern.
Expert Opinions
Janet Yellen stated, "Fiscal dominance is likely to raise term premiums and borrowing costs as investors become more concerned the government will rely on inflation or financial repression to manage its debt. For all of these reasons, avoiding fiscal dominance has been a central objective of modern central banking frameworks. Well, should we be concerned about the potential for fiscal dominance? In my opinion, the answer is yes." Moody’s Ratings also warned about the risks of fiscal dominance, stating that successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs.
What Happens Next
The Fed is widely expected to keep rates steady at its next meeting in late January. Meanwhile, President Trump has said he expects to nominate a new Fed chair, who, subject to Senate approval, will succeed Powell when his term ends in May. The outcome of these events will be crucial in determining the future of the U.S. economy and the ability of the Fed to fulfill its mandates.
Conclusion
In conclusion, the mounting national debt of the United States poses a significant risk to the country’s fiscal stability and the Fed’s ability to fulfill its mandates. The potential for fiscal dominance is a concern that should not be taken lightly, and policymakers must take action to address the growing debt and prevent a scenario where the central bank is pressured to keep interest rates low to manage the government’s debt burden. It is essential for the U.S. government to take a proactive approach to reducing its debt and ensuring the long-term stability of the economy.
