The Congressional Budget Office’s latest report on the budget outlook revealed (perhaps unintentionally) that fixating on Congress and the President as the central players in the federal deficit drama is a mistake. According to the CBO, the path the federal budget deficit will follow over the next 10 years is just as much (if not more so) a question of Federal Reserve policy.Multiplier Effect
It’s Time to Shift the Focus of the Deficit Debate
Michael Stephens
It's the interest rate, stupid. And that depends on the Fed's inflation target, since the interest rate is a policy variable.
Interest rates are a policy variable. This growth in debt-service costs, in other words, represents a choice. The question of whether or not it’s the right choice should receive a lot more attention in our popular discussions, alongside the obsession with “grand bargains” and the rest. We’re often told (in a near inversion of the truth) that rising budget deficits are the biggest near-term threat to the US economy. But if you look at what the CBO’s projection says about our collective priorities, what we see here is a decision to allow interest rates to rise at the expense of the deficit....
However, given some model of the interactions between unemployment, inflation, interest rates, and budget deficits, the question of what particular tradeoffs we are making, or should make, needs to be brought to the fore. One issue raised by the CBO’s projection is the Fed’s apparent commitment to place a 2 percent ceiling on inflation. Is maintaining this ceiling worth it, given the price that needs to be paid in terms of a more elevated unemployment rate and increased political pressure to reduce spending on essential government functions? How harmful would inflation in the 3–4 percent range be, given the costs of trying to avoid it? Whatever your answers are, these questions need to become a more routine part of the deficit debate, for the sake of better public understanding of the choices being made on our behalf.
