Fiscal & Monetary Policy Constraints

Is it reasonable to expect the future to be like the recent past? Usually, but history tends to rhyme, not repeat. I expect U.S. economic policy options to become constrained soon. If they’re not already. Let’s dig into why that could be, but first let’s see where we are today.

Factors Determining Economic Growth

Economic growth can be approximated by looking at Gross Domestic Product. Labor, capital, and productivity are key determinants of economic output. Over the last two decades the federal government has relied heavily on increasing Capital to magnify economic trends. The U.S. Treasury has spent far more than it received in tax revenues. This is called deficit spending. To fund this spending the U.S. Treasury issues debt. Increasing debt = increasing Capital = magnified economic trends.

Federal debt has increased nearly six-fold from ~$4 trillion in 2001 to almost ~$28 trillion in 2021. Over the same period, government revenues only doubled. Clearly this is not a sustainable trend. Federal spending has exceeded revenues for the last two decades. Should we be concerned about deficit spending trends? Yes.

Federal Deficit Trends Over Time

Looking through the Congressional Budget Office’s (“CBO”) 2021 Long-Term Budget Outlook the issue appears even more pressing. Within two decades net interest expense is projected to exceed the primary deficit. That’s before raising rates! The CBO generally assumes expenditures and revenues will remain stable so it’s better to think of the below as showing current trends.

Source: CBO-An Overview of the 2021 Long-Term Budget Outlook (Swagel, 2021)

How can this risk be reduced?

The Federal government needs to increase revenues or reduce spending.

Why does this matter?

The U.S. produces one of the most highly desired assets in the world, safe government debt. If the U.S. is viewed as a “bad credit”, devalues its currency, or otherwise loses the full faith of the investment world… Congress may soon face tough choices between raising taxes, reducing spending, or debasing the dollar.

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