Last week, Federal Reserve Chairman Ben Bernanke gave his Semiannual Monetary Policy Report to Congress. In it, he explained how high Federal deficits will cause interest rates to spike beyond the Fed's control:
In order to keep the ratio of outstanding government debt to GDP constant, we need to have deficits from 2.5%-3%. (The current projection of) 4-7% is not sustainable, and if that were actually to happen, we would see increasing interest costs and eventually the markets would just entirely lose confidence in our fiscal policy, and interest rates would spike. So it is very important that Congress, even though we are now still in a very deep recession or in a very weak economy, it is important for Congress to try to clarify how we are going to exit from our fiscal position and try to provide a credible blueprint for how our federal deficit will be controlled over the next ten to twenty years.
The economy is guided by two government forces. The first is monetary policy, which is the Federal Reserve's ability to add and subtract liquidity to the banking system primarily through the Fed funds rate. The second is fiscal policy, which is the Federal budget, which spurs economic growth through spending and dampens it through taxes.
Both have been expansionary, to stimulate the economy out of recession. However, the Fed has announced its exit strategy, whereby it will subtract liquidity to avoid inflation. The FY 2011 budget is wildly expansionary, to the point that no one believes it is sustainable. Unless it is reined in, out-of-control government spending will cause investors to lose faith in the ability of the U.S. government to repay its debt, and interest rates will rise. This will choke off any housing recovery, and the Fed will be powerless to do anything with monetary policy alone.
As put so well by a reader, Tony Richardson
President, RichardsonHeritage Group, Inc
Thus, unless Congress makes a 180 degree turn regarding its spending patterns between now and 2012 at the latest, it is not the Fed who will dictate interest rates, but the markets, because the Treasury will eventually have to offer higher rates to attract buyers, and the Fed will not be able to be the Treasury-security "buyer of last resort" once demand for US debt deteriorates to a certain level.
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(Photo Credit:Bill Pugliano/Getty Images)
Comments
Kimberly
Whats wrong with Reserve Bank Of Australia? Increasing Rates Vigrously? Is that only Australia which came out of recession? Or Its Economy Flying?
Its seems Incredible?
You think 4.00 could touch the 7.25
Apparently. Here’s a quote :
Australia pulled through the global economic slump better than most, thanks to 42 billion Australian dollars ($37-billion U.S.) of government stimulus spending and demand for the iron ore and other minerals that Australia exports to Asian nations including China, Japan and South Korea.
Earlier Tuesday in Canberra, International Monetary Fund deputy managing director Murilo Portugal said Australia’s economic outlook was “a good one.”
He said Australia’s resilience amid global turmoil was the result of robust demand for commodities, a flexible exchange rate, and a healthy banking sector. Timely cuts in interest rates and a sizable fiscal stimulus were also key factors,“ he said.
Kimberly
I’d be willing to buy some government bonds and cut the foreigners out for a rate that is 2% above inflation. No one worried about the debt while GW was writing all those hot checks. Why worry now?
You are so right. GW doubled the debt from $5 to $10 trillion, primarily with defense spending. No one made a peep.
I also find it interesting that everyone is yelping about the stimulus spending and health care spending, but again no one is saying anything about defense spending, which is $800 billion a year through 2012. (This counts all “security spending,” not just the defense budget.) The President who got the Nobel Peace Prize is budgeting more for security that the President known for the War on Terror. What up with that?
Kimberly
Kimberly is right about the Australian economy – it is in much better shape than the unenviable position of the US, but this is primarily due to our good fortune to be sitting on an enormous supply of mineral resources that China needs.
For the US to turn things around, it urgently needs to slash its military expenditure and put an end to its current expeditions, but the political will to do so is still only held by a minority.
Well put, James. Part of the Republican landslide in the mid-term elections was based on their promise to slash government spending. So far, the tax cut bill proves the opposite. I’m looking forward towards seeing what the new Congress does to actually trim the budget- I hope it’s not all rhetoric.