What does higher inflation mean for the country’s fiscal outlook? A trio of leading budget experts addressed the issue on Monday at the National Association for Business Economics’ annual policy conference.
Congressional Budget Office Director Phillip Swagel told the audience that the fiscal effects of inflation on federal revenue and spending largely cancel out over the 10-year budget window. “The fiscal danger is interest rates,” Swagel said. Rising rates result in higher borrowing costs for the government. “Higher inflation and higher interest rates over time lead to much higher expenses for net interest payments,” Swagel said. “The fiscal challenge, at least the short-term fiscal challenge, of higher inflation comes through the burden of debt flows.”
A recent CBO analysis found that in a scenario where inflation and interest rates are much higher than projected in its baseline forecast, cumulative deficits would be $2.3 trillion higher from 2022 to 2031, but the federal debt owned by the public as a share of the economy would be somewhat smaller at the end of this period because debt would grow more slowly than gross domestic product. And Swagel noted that net interest payments as a percentage of GDP remain subdued by historical standards.
Wendy Edelberg, director of the Hamilton Project at the Brookings Institution and former chief economist at the Congressional Budget Office, said net interest costs are unlikely to reach worrying levels over the next decade. “Rising interest rates are priced into the fiscal outlook, and the fiscal outlook, at least over the next decade, in my view, doesn’t look particularly dire.”
Edelberg also said inflationary pressures will shift over the coming year as consumers adjust their spending and shift away from goods and back to services. This can pose challenges for policy makers looking for historical parallels.
“It’s very likely that over the next year we’ll see at least a few months with outright deflation in goods,” Edelberg said, “but at the same time we’re going to see an extraordinary increase – I think , I hope – demand for services, and that’s where the worrying inflationary pressures are, and where we should be looking. So what that means is that the 70s and 80s aren’t not a good model and frankly even last year is not a good model.
Douglas Holtz-Eakin, a former CBO executive who now heads the conservative American Action Forum, said the country’s fiscal trajectory and structural fiscal problems concern him, especially as they limit our ability to invest in the areas who need it for the future. “We don’t even have the political ability to stabilize debt to GDP and since at some point you have to have that ability, that troubles me a lot.”