Higher Rates Alone Cannot Fix Washington's Debt Addiction

Can the Fed Really Stop Inflation If Congress Keeps Spending?

The Federal Reserve cannot stop inflation by itself when the federal government is borrowing more than $1 trillion every year just to pay interest on the existing debt. As long as Congress runs deficits near 6 percent of GDP, rate increases act like a bucket trying to drain an overflowing bathtub.

This is not a theory. It is arithmetic. The national debt has climbed past $37 trillion, and the Congressional Budget Office projects that interest costs alone will consume nearly 17 percent of federal revenue within a decade. Every dollar spent on interest is a dollar not spent on defense, border security, or veterans. Worse, much of that debt is financed with short-term bills, so rising rates feed directly into higher deficits.

The Fed raised the federal funds rate from near zero to a range of 4.25 to 4.50 percent between 2022 and 2025. That tightening cooled some sectors of the economy. Yet core inflation remains sticky above the central bank's 2 percent target, because Washington keeps injecting demand into the economy through deficit spending. Rate hikes cannot sterilize fiscal stimulus.

Think of it this way. The Fed can make money expensive, but Congress can still make money plentiful by borrowing and spending. When those two forces collide, the borrower wins and the saver loses. That is why grocery bills, rent, and insurance premiums stay high even as headline inflation prints come down.

What Does the Balance Sheet Tell Us About Policy Credibility?

The Fed's balance sheet remains near $6.8 trillion, far above the roughly $4 trillion level that prevailed before the pandemic, which means the central bank is still financing deficits by holding Treasury debt. Shrinking that portfolio slowly is the right technical move, but it cannot substitute for fiscal discipline.

Quantitative easing was sold as an emergency measure in 2008 and again in 2020. Emergencies ended. The balance sheet did not. The Fed now owns roughly one-fifth of all publicly held Treasury debt. That makes the central bank the Treasury's largest creditor and creates a conflict of interest every time policymakers debate rate decisions.

Reducing the balance sheet, known as quantitative tightening, removes some of that stimulus. But the process is slow and politically sensitive. A rapid unwind could spike long-term yields and destabilize regional banks still holding low-rate bonds. So the Fed tiptoes. Meanwhile, the Treasury keeps issuing debt because Congress keeps authorizing spending.

Credibility matters because inflation expectations are as much about trust as about data. If markets believe the Fed will eventually monetize the debt rather than allow a default, inflation risk premiums rise. Bond yields climb. Mortgage rates follow. Working families pay the price for a credibility gap created on Capitol Hill, not Constitution Avenue.

What Should Washington Do Instead of Blaming Powell?

Washington should cap discretionary spending, reform entitlements, and pass a balanced-budget amendment so that the Fed is no longer asked to paper over fiscal failures with monetary easing. Monetary policy sets the price of money; it cannot manufacture the political will to live within our means.

The last time the federal budget was balanced was fiscal year 2001. Since then, both parties have treated borrowing as a free lunch. Emergency spending became baseline spending. Temporary programs became permanent entitlements. And every time a crisis arrived, the answer was more debt. The Fed enabled the habit by keeping rates low and buying bonds.

Real reform starts with honest accounting. Congress should score legislation using realistic growth assumptions and stop hiding costs in out-years. It should freeze non-defense discretionary spending and demand that every new program find an offset. Social Security and Medicare, which face insolvency in the next decade, need structural changes that protect current retirees while adjusting eligibility for younger workers.

The balanced-budget amendment is not a magic wand. But it would force politicians to justify new spending to voters instead of passing the bill to future generations. It would also restore the Fed's independence by removing the implicit expectation that the central bank will always ride to the rescue when tax revenue falls short.

Why Markets Should Prepare for Volatility

Investors are waking up to the fact that Treasury yields may stay elevated even if the Fed cuts rates, because lenders demand a risk premium on a country that borrows without limit. The 10-year Treasury yield has hovered near 4.3 percent in 2025, and the spread between yields and inflation expectations is widening.

The bond market is called the wisdom of crowds for a reason. When global buyers demand higher returns to lend to Uncle Sam, they are pricing in default risk, inflation risk, and currency risk all at once. A country that borrows in its own currency cannot technically default, but it can inflate away its obligations. That is just a different kind of theft.

Stock valuations have remained resilient partly because investors believe the Fed will cut rates if growth slows. That assumption may fail if inflation stays sticky while growth stalls, the dreaded stagflation scenario of the 1970s. During that decade, the S&P 500 delivered negative real returns for years. There is no law saying it cannot happen again.

The dollar's reserve status gives America enormous privilege, but privilege can be squandered. China, Russia, and Gulf states are building payment systems and gold reserves precisely to reduce dependence on the dollar. A fiscally reckless America accelerates that trend. The Fed cannot print credibility.

The Hard Truth

There is no monetary fix for a spending problem, because the Federal Reserve controls only short-term interest rates and the size of its balance sheet while Congress controls the budget. Until the second institution behaves, the first will keep chasing its tail.

Conservatives should stop pretending that the right Fed chair can solve problems created by decades of bipartisan profligacy. We need a Fed that is independent, competent, and credible. We also need a Congress that stops treating the nation's credit card like a campaign donor. The path to stable prices runs through the Capitol, not the Marriner S. Eccles Building.

A former Fed chairman once described the central bank's job as taking away the punch bowl just as the party gets going. Today the party is in the congressional appropriations committees. And nobody in Washington wants to go home.