Fed’s Jackson Hole Reveals US Government Fiscal Deficits are Unfixable without Unexpected Inflation

August 29, 2023

Powell reiterated that 2% inflation is the Fed’s (The Federal Reserve) target, with inflation currently running closer to 3% headline and 4% core. Fed governor’s concur with Powell, putting their line in the sand at 2%.

The Fed balance sheet is one of the primary drivers of inflation, depressing interest rates for close to 14 years from 2008 to 2022 as its balance sheet swelled from $800 Billion to $8.9 Trillion. The Fed is reducing this by $1 Trillion per year, in order to move it back to more normalized levels. The 14 year explosion which included buying US government bonds helped finance the federal government which has been running massive deficits which now approach $2 Trillion per year.

Assuming GDP of 2% and an inflation rate of 3%, we would have nominal GDP of 5%. Historically, the 10 year and 30 year treasuries rates have approximated nominal GDP. This means the long part of the curve still needs higher rates to be normalized.

The Fed research paper delivered at Jackson Hole has all-but-admitted that there is no way to rollback the federal debt. Stating that budget surpluses or statutory ceilings on interest rates as a mechanism of financial repression are no longer politically possible. The final point, is that inflation can help finance the federal debt but only if inflation spikes to unexpected levels. This unexpected inflation can help the federal government pay off its debt very quickly, which happened just after the second world war in the United States. This, in our opinion, is the reason Fed has constantly railed on the 2% inflation target figure. They want you to believe 2% so inflation can run higher than expected and help reduce the debt burden.