Chairman Warsh’s Dilemma
Fed Chairman Kevin Warsh has inherited a dilemma that no FOMC can solve with monetary policy alone.
So long as Congress runs fiscal deficits of 6% of GDP and the federal debt-to-GDP ratio continues to increase, the FOMC and Chairman Warsh cannot offset the longer-run resulting adverse consequences for the U.S. economy.
If Congress runs large deficits, the Treasury must conduct ever-larger debt auctions to renew the maturing debt and finance new borrowing.
If the Fed accommodates the growing deficits with money creation to assure ample liquidity and to suppress interest rates, higher asset-price inflation and/or consumer-price inflation will persist or worsen, distorting and undermining the economy.
If, on the other hand, the FOMC refuses to monetize the excess debt, the private sector must absorb the expanding supply of Treasury securities. As private capital is siphoned away to finance public borrowing, interest rates will likely rise, slowing the economy and increasing recession risks.
The only way to avoid this dilemma is for Congress to address America’s real problem: the growing national debt. The FOMC should say as much and stop insisting that it can’t talk about it. The Fed is independent precisely for that purpose.