Will the Fed Take the Punch Bowl Away?

Will the Fed Take the Punch Bowl Away?

© Issei Kato / Reuters

Although weaker public-sector spending may help explain the slow-growth rut the U.S. has found itself in over the last decade, most economists say that the extraordinary deficit-financed stimulus at this stage of the economic cycle won’t provide much more than a temporary sugar rush for the economy. Bloomberg’s Jonathan Bernstein says that President Trump’s policies have been focused largely on short-term economic gains, and their effects – namely higher growth and higher deficits – will push the Federal Reserve to raise interest rates as it attempts to deal with rising inflation and ever-expanding federal debt:

“[Trump’s] preferred combination of loose fiscal and monetary policy — of large federal budget deficits along with low interest rates — also may run up against reality. The Fed isn’t just randomly imposing higher interest rates; its actions are a perfectly predictable (and, most economists would say, responsible) reaction to continued growth and those enormous federal budget deficits that Trump and congressional Republicans have created.”

Similarly, Bloomberg’s Ramesh Ponnuru warns that the Fed’s monetary policy may end up limiting the boost provided by fiscal policy: “The Fed offsets the impact of changes in the deficit even if its policymakers are not consciously trying to do so. The central bank need only respond in roughly consistent ways to trends in unemployment, inflation and other economic variables for its behavior to counteract fiscal stimulus.” Ponnoru says that, in the end, the U.S. will be left with a “bigger national debt, which comes with an obligation to pay greater amounts of interest.”