THE GLOBAL ECONOMY IN BIBLE PROPHECY 14.10.2022
3. Central banks and
3.1 US federal debt makes difficult to tame inflation
John H. Cochrane: Chigago Booth Review 3.11.2021
Monetary policy lives in the shadow of debt. US federal debt held by the public was about 25 percent of GDP in 1980, when Federal Reserve chair Paul Volcker started raising rates to tame inflation. Now, it is 100 percent of GDP and rising quickly, with no end in sight. When the Fed raises interest rates 1 percentage point, it raises the interest costs on debt by 1 percentage point, and, at 100 percent debt to GDP, 1 percent of GDP is about $227 billion. A 7.5 percent interest rate therefore creates interest costs of 7.5 percent of GDP, or $1.7 trillion.
Where will those trillions of dollars come from? Congress could drastically cut spending or find ways to increase tax revenues. Alternatively, the US Treasury could try to borrow additional trillions. But for that option to work, bond buyers must be convinced that a future Congress will cut spending or raise tax revenues by the same trillions of dollars, plus interest. Even if investors seem confident at the moment, we cannot assume that they will remain so indefinitely, especially if additional borrowing serves only to pay higher interest on existing debt. Even for the United States, there is a point at which bond investors see the end coming and demand even higher interest rates as a risk premium, thereby raising debt costs even more, in a spiral that leads to a debt crisis or to a sharp and uncontrollable surge of inflation. If the US government could borrow arbitrary amounts and never worry about repayment, it could send its citizens checks forever and nobody would have to work or pay taxes again. Alas, we do not live in that fanciful world.
The US experienced a two-decade economic boom. A larger GDP boosted tax revenues, enabling debt repayment despite high real-interest rates. By the late 1990s Even if the economic boom that produced fiscal surpluses was coincidental with tax and regulatory reform, the fact remains that the US government successfully paid off its debt, including debt incurred from the high interest costs of the early 1980s. But would that kind of successful stabilization happen now, with the US national debt four times larger and still rising. Would Congress really abandon its ambitious spending plans, or raise tax revenues by trillions, all to pay a windfall of interest payments to largely wealthy and foreign bondholders?
Arguably, it would not. If interest costs on the debt were to spiral upward, Congress would likely demand a reversal of the high interest-rate policy. The last time the US debt-to-GDP ratio was 100 percent, at the end of World War II, the Fed was explicitly instructed to hold down interest costs on US debt, until inflation erupted in the 1950s.The unraveling can be slow or fast. It takes time for higher interest rates to raise interest costs, as debt is rolled over. The government can borrow as long as people believe that the fiscal reckoning will come in the future. But when people lose that faith, things can unravel quickly and unpredictably.
3.2 Central banks will fail to tame inflation without better fiscal policy
Federal Reserve's Jackson Hole Economic Symposium: Reuters 28.8.2022