What Can the Fed Do About the Deficit? Nothing
Federal Reserve officials say soaring long-term bond yields are a key factor in the economic outlook and their interest-rate decisions. They also say the swelling federal deficit is one reason yields are rising. What they won’t say is that political leaders should therefore do something about the deficit.
“We don’t comment on fiscal policy," Fed Chair Jerome Powell told a questioner after a speech last week. “We know that we’re on an unsustainable path fiscally." Powell’s reticence is understandable. But it is also selective.
In 2020, when pandemic lockdowns tipped the economy into a sharp, severe contraction, Powell had a lot to say about fiscal policy. After Congress passed and President Donald Trump signed the $2.2 trillion Cares Act, Powell repeatedly called for more stimulus. “This is the time to use the great fiscal power of the United States to do what we can to support the economy," he said in April 2020.
Powell kept up his support through fall 2020. And while he didn’t explicitly back President Biden’s $1.9 trillion American Rescue Plan in early 2021, he did play down concern that inflation could result. His call for more fiscal support was, at the time, well-founded.
The early-2020 lockdowns represented an unprecedented calamity. The Fed had already cut short-term interest rates to near zero and was buying bonds to push down long-term rates; fiscal policy was the only lever left to support the economy. Nonetheless, Powell’s outspoken support for fiscal stimulus then is awkward now, for two reasons.
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