THE FED IS LOSING THE INFLATION WAR — BECAUSE THE DEBT HAS BECOME THE BOSS
Fiscal dominance is no longer a theoretical risk. It is becoming the central question for U.S. monetary policy.
For years, economists have repeated a reassuring sentence:
The Federal Reserve is independent.
Perhaps legally.
Perhaps institutionally.
But financial markets are beginning to ask a much more uncomfortable question:
Can the Fed really remain independent when the cost of government debt becomes large enough to constrain monetary policy?
That is the question surrounding Jackson Hole this week.
And it is a much bigger question than whether the Fed cuts rates in September.
The problem nobody can solve with a rate cut
The United States has accumulated an extraordinary amount of debt.
Federal debt has risen from roughly $3.4 trillion in 2000 to more than $32 trillion in debt held by the public, according to a recent Financial Times analysis, while interest costs have become a dramatically larger burden on federal revenues.
At the same time, inflation remains above the Federal Reserve’s 2% target.
Reuters reported that July PCE inflation was running at 3.7%, while several Fed officials warned at Jackson Hole that inflation remains too persistent to declare victory.
This creates the trap.
If the Fed keeps rates high:
the government pays more to finance its debt.
If the Fed cuts rates too aggressively:
inflation may remain above target or become entrenched.
And if inflation remains above target while the government continues running large deficits:
the credibility of monetary policy becomes the real casualty.
This is where the phrase fiscal dominance becomes important.
What is fiscal dominance?
Fiscal dominance occurs when monetary policy becomes constrained by fiscal policy.
In simple terms: