Fighting inflation and ensuring US fiscal health start now

Inflation and rising interest rates will have seriously negative effects on the United States’ fiscal outlook

Inflation’s impact on a fiscal budget could be viewed as a neutralizer: on the one hand, it raises revenues and lowers annual federal budget deficits and accumulated public debt in real terms; at the same time, it raises the cost of goods and services, which further inflates government expenditures and worsens fiscal gauges, which are usually monitored in nominal terms.

But the challenge is the already very large and accumulated debt and the rising cost of servicing that debt as interest rates rise, compounding the amount of public debt owed and shrinking the budget resources available to address the needs of the nation or its ability to respond to a crisis.

However, policymakers have options for addressing inflation and for slowing, perhaps even reversing, the trend toward sovereign debt accumulation. But fiscal policies need to be carefully calibrated to ensure that addressing inflation does not trigger deep recessions. Spending needs to be measured, cut where possible, tightened to promote work and productivity and avoid stimulus, and paid for. And perhaps most importantly, our nation’s leaders need to provide the political will for change. This will for change is most needed to address Social Security and Medicare, which dominate the federal budget and whose Trust Funds, along with the Highway Trust Fund, are going insolvent.

A shallow yet brief recession before the end of 2022 and into 2023 may be inevitable as the Federal Reserve is expected to raise interest rates rapidly and into what might be considered restrictive territory (i.e., above 3 percent) (see The Conference Board Economic Forecast for the US Economy). Additionally, more fiscal stimulus in the short run—that is, spending apart from the usual automatic stabilizers that kick in during a recession—is likely not appropriate as it may fuel further inflation. However, this interlude will pass, and the federal government must focus upon fiscal sustainability and economic growth for the long haul. Achieving these aims means addressing the root causes of outsized annual federal budget deficits and ballooning public debt—starting now.

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