Prioritizing economic policy objectives

With much of the media focusing on the plans and objectives being articulated by Trump and his many prospective appointees, I fear that many of us are being distracted from what may be the most important economic policy consideration deserving of our attention.

At the risk of oversimplification, fiscal and monetary policy are levers that our government can use to affect macroeconomic conditions. Expansionary policies are appropriate when unemployment is deemed to be excessive or economic growth is perceived to be too slow; contractionary policies are appropriate when inflation is the larger concern. For monetary policy, an expansionary policy involves stepping up the pace of monetary growth and thus lowering interest rates; contractionary policy would be the reverse. For fiscal policy, expansionary policy involves increasing government spending or lowering taxes (i.e., generally increasing the size of the deficit); and, again, in a similar manner, contractionary policy would be the reverse – lower spending and/or higher taxes.

So where are we now? Even though many critical prices remain high, inflation has largely been brought under control. After posting a year-over-year inflation rate higher than 9 percent in June of 2022, the latest reading was 2.6 percent for the 12 months ending in October this year. With the Fed’s publicly stated objective of bringing inflation down to 2 percent, we’re not ready to claim victory yet; but we’re certainly close, and we’ve come a long way.

On the employment front, the latest unemployment rate edged up in November to 4.2 percent. This rate had spiked in April of 2022 when the pandemic hit, reaching 14.8 percent. Since then, aided by an aggressively expansive fiscal policy, the unemployment rate got as low as 3.4 percent in early 2022. It’s crept up since then, coming in at 4.2 percent this November; but it’s still low by historical standards.

In other words, we seem to be close to a “goldilocks moment”. We may not be able to say, “just right,” but we’re not far off on both counts. Any new bold or aggressive policy initiative – either expansionary or contractionary – poses unacceptable risks. That is, an overly expansionary policy would risk a renewed bout of inflation; and similarly, an overly contractionary policy would risk throwing an unacceptable number of people out of work. These conditions call for both our fiscal and monetary authorities to play it safe by maintaining as near a neutral policy as possible, for as long as possible – i.e., until inflation or unemployment reveals itself to be the more pressing problem that would necessarily have to be addressed.

The good news is that because the pressure is off for any substantial contracyclical policy – expansionary or contractionary -- it’s both reasonable and appropriate for our fiscal authorities to turn their attention to managing the federal debt. (This orientation falls strictly under the jurisdiction of Congress and the Administration, but outside the realm of authority for the Fed.) Critically, it’s not the debt, per se, that’s a problem. Rather, it’s the carrying costs on this debt – i.e., the interest expenses that need to be paid in connection with this debt. These carrying costs skyrocketed by 33.7 percent in fiscal 2024 (ending September 30, 2024), causing this category of spending to account for a record 14 percent of total federal government outlays. To put this in perspective, we spent more on the net interest on the national debt in 2024 than we did on defense!

Given the relatively benign states of inflation and unemployment, reducing our debt burden should take over as the number one economic policy goal. At least in theory, Congress controls the purse strings, so we should be looking to Congress to set this direction; but with Republicans claiming majorities in both Houses of the coming Congress, Congress seems likely to be taking its cues from Trump, with Elon Musk and Vivek Ramaswami acting as his emissaries.

Musk and Ramaswami have been meeting with members of Congress, pushing for massive cuts in government spending with little regard for the havoc that these cuts would have on millions of government workers and contractors who would lose their livelihoods. Such reductions in government spending in the levels as those being promoted, however, would be dangerously contractionary at a time when a very measured – i.e., gradual -- effort to shrink deficits is in order. Will Congress succumb to Trump’s pressures? We’ll have to wait and see.