Fed’s Powell Warns US Budget on ‘Unsustainable Path’

Federal Reserve Board Chairman Jerome Powell testifies before a House Financial Services Committee hearing on the Federal Reserve's Semi-Annual Monetary Policy Report, on Capitol Hill in Washington, on June 21, 2023. (Stefani Reynolds/AFP via Getty Images)

The U.S. budget is on an unsustainable path, which makes it crucial for policymakers to deal with it sooner rather than later, Federal Reserve Chair Jerome Powell told senators on June 22.

During Powell’s testimony before the Senate Banking Committee about his semi-annual monetary policy report, several Republican senators pressed him on the federal budget and its effect on inflation.

Sen. Tim Scott (R-S.C.), the committee’s ranking Republican member, noted that the actions Congress takes “impacts significantly what you’ve had to do in order to slow down Biden’s absolutely explosive inflation.”

The central bank chief stopped short of critiquing fiscal policy, but he did concede that the federal budget “is on an unsustainable path.”

“It has been so for a long time. We need to deal with that sooner or later, and sooner is better than later. That’s about, but that’s what I can say, and that’s what essentially all of my predecessors have said,” Powell stated. “We are not charged with supervising fiscal policy in any way. It’s just as a high-level matter from the standpoint of the economy.”

In an exchange with Sen. John Kennedy (R-La.), Powell agreed that less government spending and fewer stimulus measures tend to be disinflationary. At the same time, he indicated a 10 percent reduction in federal spending could result in less demand and potentially slow the economy.

Sen. Tim Scott (R-S.C.) meets with guests at the Iowa Faith & Freedom Coalition in Clive, Iowa, on April 22, 2023. (Madalina Vasiliu/The Epoch Times)

“Less demand would mean less economic activity, less spending, and that would have a negative effect on inflation,” Powell said.

After President Joe Biden signed the Fiscal Responsibility Act into law, the national debt topped $32 trillion for the first time, including $25 trillion in debt held by the public and about $7 trillion in intragovernmental debt. Following the signing, the U.S. government borrowed close to $400 billion in one business day.

Inflation and Interest Rates

Although inflation continues to run higher than the Fed’s goal, Powell does see a path of slowing price growth without substantial job losses. Fed officials do expect modest increases in the unemployment rates and gradual cooling, but “most of the loosening will come in the form of other ways.”

“Our part of it is to try to get inflation under control, and that’s what we’re doing,” he said. “Ideally, we'll do that with as little as possible damage to the economy in the labor market.”

This was the second day of testimony for Powell, who appeared before the House Financial Services Committee on June 21. He told House lawmakers that more rate hikes are ahead. While inflation has cooled, it “remains well above” the central bank’s 2 percent target rate, indicating the policymakers have more work to do.

“Inflation has moderated somewhat since the middle of last year,” he said. “Nonetheless, inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go.”

Powell explained that lowering inflation will be achieved by slowing the U.S. economy to below-trend growth. But officials will continue to be data-dependent and make decisions on a meeting-by-meeting basis.

In May, the annual inflation rate slowed to 4 percent, down from 4.9 percent in April and below the consensus estimate of 4.1 percent. The core inflation rate, which strips the volatile energy and food sectors, eased to 5.3 percent, down from 5.5 percent.

“We have been seeing the effects of our policy tightening on demand in the most interest rate-sensitive sectors of the economy,” the Fed chief stated. “It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation.”

According to the CME FedWatch Tool, the futures market is mostly pricing in a quarter-point rate hike at next month’s Federal Open Market Committee (FOMC) policy meeting.

Last week, the Fed signaled two more rate increases this year, with the Survey of Economic Projections (SEP) showing that officials believe the median policy rate will climb to 5.6 percent from the March SEP of 5.1 percent. Officials also raised the benchmark fed funds rate expectation to 4.6 percent in 2024 from 4.3 percent in the March estimate.

What Other Fed Officials Are Saying

Many regional central bank leaders have been participating in interviews and delivering speeches since last week’s FOMC meeting. A common message among these officials is that they are concerned the institution will overshoot, meaning policymakers will raise interest rates too much and trigger a recession.

Raphael W. Bostic, president and CEO of the Federal Reserve Bank of Atlanta, speaks at a European Financial Forum event in Dublin on Feb. 13, 2019. (Clodagh Kilcoyne/Reuters)

Raphael Bostic, head of the Federal Reserve Bank of Atlanta, told Yahoo Finance that his baseline estimate is that interest rates should remain unchanged for the rest of the year. Bostic, who didn’t anticipate an additional rate hike in the dot plot, stated that he wants to ensure the United States can “avoid a significant economic downturn.”

“I feel we have a little bit of time to play out and see exactly how much the economy is responding to our policy,” he said. “I do feel like we are in a position where some patience will do us well.”

The Atlanta Fed GDPNow model estimate shows the U.S. economy will record 1.9 percent growth in the second quarter.

Chicago Fed President Austan Goolsbee explained in an interview with The Wall Street Journal that the central bank must do some “more sniffing” on the economy and inflation before choosing to resume rate hikes.

“I have not decided what should be the rate decision more than a month from now,” he said.

Fed Governor Michelle Bowman supported skipping a rate hike but thinks additional increases will be needed to combat core inflation.

“Although tighter monetary policy has had some effect on economic activity and inflation to date, we have seen core inflation essentially plateau since the fall of 2022, and I expect that we will need to increase the federal funds rate further to achieve a sufficiently restrictive stance of monetary policy to meaningfully and durably bring inflation down,” Bowman said in opening remarks at Policy Summit 2023.

After 10 consecutive rate increases, the Federal Reserve hit the pause button at the June FOMC meeting.