The S&P 500, the Dow Jones Industrial Average, and NASDAQ all fell sharply yesterday after a federal government report indicated inflation remains a persistent problem.
That news comes on the heels of the U.S. Congressional Budget Office (CBO), the agency within the federal legislative branch that examines how legislation that lawmakers may vote on will affect the country’s long-term fiscal and economic situation, releasing its annual outlook for the nation’s economy and federal budget. That annual report outlines how public policy as it stands today (without any proposed changes considered) will affect annual budget deficits, the national debt, and U.S. economic growth.
How are these two developments related, what does the CBO report say about the country’s economic and fiscal situation, and how could all this news affect ongoing fiscal year 2024 appropriations negotiations? After all, the most recent continuing resolution keeping the government open expires in just a few weeks.
Let’s take a look.
What Did The Inflation And CBO Reports Say?
The U.S. Bureau of Labor Statistics announced yesterday that consumer prices in the country rose 3.1 percent between January 2023 and January 2024. (Housing prices, rather than gas or food, were the main reason for the increase.) While that expansion was lower than in December, economists had been hoping for — indeed, predicting — a much lower number.
Why were they hoping for a better report? Because a lower number would have increased the likelihood that the Federal Reserve would lower the target interest rate when it meets next month. The 3.1 percent report tempered expectations for interest rate reductions.
A week before yesterday’s inflation announcement, the CBO reported the annual federal deficit, which is the gap between a fiscal year’s overall spending and the revenue the federal government takes in, will be $1.6 trillion in FY 2024, $1.8 trillion in FY 2025, and $1.6 trillion in FY 2027. The deficit will rise to $2.6 trillion in 2034, or a number that is approximately 6.1 percent of the total size of U.S. gross domestic product (GDP, the size of the economy).
That number may seem small, but the CBO noted, “Since the Great Depression, deficits have exceeded that level only during and shortly after World War II, the 2007–2009 financial crisis, and the coronavirus pandemic.” In other words, deficits are usually only this high when the country is facing a severe crisis that requires additional – and temporary – federal spending.
These annual spending gaps add up. Indeed, CBO predicted that debt held by the public (the United States’ national debt, or cumulative result of annual federal deficits) will increase from 99 percent of GDP at the end of calendar year 2024 to 116 percent of GDP by the end of 2024. That number would be the highest level ever recorded in the country’s history.
The CBO also warned that, “after 2034, debt would continue to grow if current laws generally remained unchanged.”
Some economists believe that outcome could spell trouble for future inflation.
How Could Federal Debt And Deficits Affect Inflation?
According to the nonpartisan think tank the Peter Peterson Foundation, “Rising debt reduces business investment and slows economic growth. It also increases expectations of higher rates of inflation and erosion of confidence in the U.S. dollar.”
A study of 48 emerging and low-income economies and 34 advanced economies after the COVID-19 pandemic — a crisis in which governments increased spending to protect citizens from illness and businesses from the effects of mandated shutdowns — found a surprise 10 percent increase in a government’s debt to GDP ratio “leads to a significant increase in long-term inflation expectations after about two years.”
The libertarian Cato Institute, which favors reduced federal spending, concluded, “Without a course correction, the United States risks either a depressed economy below its full potential with recurring bouts of inflation that eat away at Americans’ savings and incomes or a sudden and severe fiscal crisis where bondholders lose confidence in the Treasury’s ability or willingness to service debt.”
Not a happy scenario. There is also this problem: rising inflation, as Americans have seen over the last few years, generally leads to higher interest rates.
Rising interest rates harm consumers, but they also make it more difficult for the U.S. government to service its debt. More money would have to be directed toward servicing the debt, which means federal lawmakers would have less money for other priorities. Here is how the Peterson Foundation sums up that scenario: “Higher interest costs could crowd out important public investments that can fuel economic growth — priority areas like education, research and development, and infrastructure. A nation saddled with debt will have less to invest in its own future.”
The CBO’s data backs up this claim. It said, “Starting next year, net interest costs are greater in relation to GDP than at any point since at least 1940, the first year for which the Office of Management and Budget reports such data.”
To be sure, not all analysts agree that high debt and deficits result in higher inflation. As The Wall Street Journal’s Andrew Duehren noted last September, federal deficits “exploded” in 2023, but inflation actually retreated. (At least it had until January …) An article from the early part of this century by a researcher at the Federal Reserve Bank of Philadelphia was similarly clear. Keith Sill said, “[F]or developed countries, such as the U.S., which tend to have relatively low inflation, there is little evidence of a tie between deficit spending and inflation.”
And what do lawmakers believe about the connection between debt and deficits and inflation, and how could those beliefs impact Congress’ ability to avoid a full or partial government shutdown next month? Let’s take a look.
What Were Lawmakers Reactions To The News … And How Could It All Impact Spending Talks?
As a reminder, members of Congress face two upcoming deadlines for FY 2024:
- On March 1, funding for four of the 12 annual spending bills expires. These are the Agriculture, Energy and Water, Military Construction and Veterans Affairs, and Transportation and Housing and Urban Development funding bills.
- On March 8, funding for the other eight pieces of legislation expires. These are the Commerce-Justice-Science; Defense; Financial Services and General Government; Homeland Security; Interior and the Environment; Labor, Education, and Health and Human Services; the Legislative Branch, and State and Foreign Operations bills.
Lawmakers are already mired in fights about border funding, emergency aid for Ukraine, Taiwan, and Israel, and tax policy. The CBO’s news about the country’s burgeoning federal debt and deficit problems is not likely to relieve pressure on spending negotiations.
In fact, that news may have caused some lawmakers to retreat further into their trenches.
Senate Budget Committee Ranking Member Charles Grassley (R-Iowa) said, “Congress ought to interpret CBO’s projections as a ‘call to action:’ the federal government must break from its irresponsible spending pattern. Otherwise, Americans will soon find themselves paying more to cover national debt and interest costs than to fund programs that matter.” Sen. Mitt Romney (R-Utah) agreed. He said, “The U.S. economy is becoming critically fragile as we continue to ignore our public debt crisis. Without action, we risk economic and geopolitical collapse.”
These two lawmakers traditionally have been relatively willing to negotiate with Democrats when it comes to spending matters.
What about House Republicans, who have been fighting for months for deep spending cuts during negotiations over FY 2024 spending?
They were remarkably silent after the CBO issued its report last week — instead groups like the House Freedom Caucus were fully focused on border security and immigration negotiations — but there is little doubt the CBO’s report is weighing on behind the scenes negotiations.
As the left-leaning Center for American Progress explained last fall, Republicans would like to make at least $58 billion in cuts to nondefense programs beyond the reductions that were agreed to by the White House and former House Speaker Kevin McCarthy (R-Calif.) in the debt ceiling deal negotiated last summer. Overall, these cuts “would leave these programs at their lowest levels since at least 1962 — the oldest year for which there are reliable data — when measured as a percentage of gross domestic product (GDP).”
Additionally, just last month, House Speaker Mike Johnson (R-La.) tweeted, “The national debt is the greatest threat to America’s national security, and the current addiction to reckless spending cannot be sustained. Lawmakers from both sides of the aisle have a responsibility to reduce spending and finally put America on path towards fiscal sanity.”
As the U.S. government barrels toward two more fiscal policy deadlines in the coming three weeks, expect to hear a lot more rhetoric like those words from Speaker Johnson, along with demands to further cut spending.