What does higher inflation mean for the nation’s fiscal outlook? A trio of leading budget experts tackled that question Monday at the annual policy conference of the National Association for Business Economics.
Congressional Budget Office Director Phillip Swagel told the audience that the fiscal effects of inflation on federal revenue and spending largely cancel each other out over the 10-year budget window. “The fiscal danger is interest rates,” Swagel said. Rising rates lead to higher borrowing costs for the government. “Higher inflation and higher interest rates over time lead to much higher outlays for net interest payments,” Swagel said. “The fiscal challenge, at least the near-term fiscal challenge, of higher inflation is coming through the flow burden of the debt.”
A recent CBO analysis found that, in a scenario where both inflation and interest rates are much higher than it projects in its baseline forecast, cumulative deficits would be $2.3 trillion larger from 2022 through 2031, but federal debt held by the public as a share of the economy would be a smidge smaller at the end of that period because debt would rise more slowly than gross domestic product. And Swagel noted that net interest payments as a share of GDP remain moderate by historical standards.
Wendy Edelberg, the director of The Hamilton Project at the Brookings Institution and a former chief economist at the Congressional Budget Office, said that net interest costs don’t look set to rise to worrying levels over the next decade. “Rising interest rates are baked in to the fiscal outlook and the fiscal outlook, at least over the next decade, to my mind, does not look particularly dire.”
Edelberg also said that inflationary pressures would shift over the coming year as consumers adjust their spending and pivot away from goods and back to services. That may pose challenges to policymakers looking for historical parallels.
“It is very likely that over the next year we will at least see some months with outright goods deflation,” Edelberg said, “but at the same time we’re going to see an extraordinary increase — I think, I hope — in demand for services, and that’s where the worrying inflationary pressures are, and where we should be looking. So what this means is, the ‘70s and ‘80s is not a good template and, frankly even the last year is not a good template.
Douglas Holtz-Eakin, a former CBO director who now heads the conservative American Action Forum, said that the nation’s fiscal trajectory and its structural budget problems concern him, especially as they limit our ability to invest in areas of need for the future. “We do not have the political capability to even stabilize debt relative to GDP and since at some point you have to have that capability, that troubles me a lot.”