Cuts And Inflation – How the Government Could End Two Birds with One Stone
Amidst the current debt ceiling debacle and the Federal Reserve’s persistence to bring inflation down to manageable levels, there is one potential fix that can alleviate pressures on both sides: federal spending cuts. Inflation, simplistically, is the increase in the prices of goods and services caused by large influxes of demand. In response to inflation, the Federal Reserve will raise borrowing costs as a method to lower demand, which will in turn lower inflation. Historically, when the federal government reduces its spending, aggregate demand in the economy will also fall, leading to disinflation. Now how does this tie into the U.S.’s debt ceiling?
Currently, both the Republican and Democratic parties are unable to compromise to initiate a lift in the debt ceiling, solely because the Republican party has demanded federal spending cuts in return. Although the Biden administration regrets a similar trade-off for spending reductions in 2011, this instance would be more warranted than ever. Analysts have hypothesized that decreases in government spending could lead to the Federal Reserve slashing rates sooner. This could, in turn, spare midsized banks and several other industries that have been wounded by the higher borrowing costs. Whether the Democratic party agrees to the demands of the Republicans, there is a chance that April’s inflation data shows great effectiveness from the Fed’s fiscal policy and the chance of a soft landing later this year.
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I am not a financial advisor and my comments should never be taken as financial advice. Investments come with risk, so always do your research and analysis beforehand.
