American Consequences - October 2018

the risk of some inflation. Neutral rates are a “sweet spot” that neither increase unemployment nor push inflation above the Fed’s 2% target. Although the current rate-hike path remains on target, there’s one economic measure that these hikes haven’t fully accounted for... According to the U.S. Treasury, the deficit grew 17% this past fiscal year to a record $779 billion, the highest level since 2012. Revenues saw a less than 1% increase over last year, while spending grew by over 3%. And tax revenues saw a 31% drop from corporations, while personal income tax revenues were up by 6%. Additionally, the Congressional Budget Office estimates that at the current rate the deficit will surpass $1 trillion in 2020, with much of this increase being blamed on recent legislation and the 2017 GOP tax bill. According to a recent report from the nonpartisan Committee for a Responsible Federal Budget, legislation passed in the 2018 fiscal year will account for $445 billion worth of 2019’s $973 billion budget deficit, or 46% of the total. And in total, legislation enacted in the 2018 fiscal year will add $2.4 trillion in new debt by 2027. In response, the White House has promised to release a plan to control the deficit, but the details are scarce. It is believed the plan will focus on spending cuts – including programs like Medicare and Social Security – and will have little to no impact on current revenues. A $779 billion budget deficit...

What could possibly go wrong?

The U.S. economy is expanding at a pace that is driving up interest rates, inflation, and wages. But this boost in economic growth also means higher interest payments for the government in the future... and an even wider deficit. It’s easy for politicians to blame the Fed for a falling market or a recession... But it’s not the Fed’s job to prop up the markets. The Fed can set credible inflation expectations – which it’s doing with its current policy – but gradual, planned rate hikes are not known to be historic market movers.

Today, the deficit is soaring as the economy booms... a combination that economists say is uncharted territory.

Usually, government borrowing expands during recessions and wanes in recoveries. Today, the deficit is soaring as the economy booms... a combination that economists say is uncharted territory. When the economy is good, political leaders are often hesitant to make bold economic moves... especially when they’re up for re- election. But if the economy weakens, the government will find it more difficult to cut taxes and increase spending. And with a deficit set to surpass $1 trillion in less than two years, we’re going to need more than just rate changes from the Federal Reserve.

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