US Interest Rates and the National Debt Dilemma: The Federal Reserve’s Strategy with Global Stakes at Play
The Federal Reserve plays an essential role in balancing fiscal and monetary policies to shape the U.S. economy, through interest rate manipulation aimed at controlling inflation or stimulating it when necessary. Their most recent move – selling more government debt to increase interest rates at a time when U.S. national debt levels have skyrocketed to $33.17 trillion and major foreign creditors like China are selling down their holdings of U.S. bonds – highlights its influence. Adjusting interest rates is one of the Fed’s primary tools to combat inflation. By selling off more government securities and restricting money supply through selling off more securities to investors, they use funds that otherwise might have been available for lending or spending instead to buy government bonds with. When money supply tightens and interest rates increase, borrowing becomes more expensive, thus decreasing inflationary pressures.
This strategy does not come without challenges. Interest payments have become a significant budget item, costing $879 billion, and U.S. debt has reached record high levels. At the same time, though, as the Fed sells more bonds to control money supply and interest rate they also increase future obligations for government – creating an ironic situation wherein solutions to today’s economic difficulties may also become tomorrow’s fiscal headaches. China, one of the largest U.S. bond holders, is steadily decreasing its holdings of U.S. Treasury Securities since 1999 – dropping by over $100 billion to their lowest levels ever for 14 years and representing an impactful change that may alter global financial markets.
Political considerations impose additional obstacles on financial machinations. Recent agreement to increase the debt limit avoided an unprecedented default; increasing it has been an issue of great political debate; however, its purpose remains clear; not authorizing new spending but meeting existing financial obligations (such as interest payments on national debt). Potential consequences of defaulting on debt could be severe. Economists warn that it could trigger a global financial crisis. While U.S. Treasury’s ability to take extraordinary measures in order to avoid default is only a temporary solution; eventually, fiscal imbalance must be addressed head-on.
Global economic health is intimately intertwined with that of the U.S. Creditworthiness. It is key for global financial stability as the US Government issues the primary reserve currency and its economy is the world’s largest. An insolvent U.S. would send shock waves through global finance; default would bring financial chaos worldwide. The Federal Reserve’s strategy of selling more debt in order to control interest rates is an ambitious one, given the high national debt level and geopolitical complexities surrounding holding international debt. Although raising the debt limit has provided temporary relief, challenges associated with managing the national deficit and its effect on the global economy still exist and policymakers’ decisions as they navigate these hurdles will have long-term effects both locally and globally.
Article Written by Qijun Ma
Sources:
https://www.nytimes.com/2023/05/02/business/economy/us-debt-ceiling.html
https://www.nytimes.com/2023/05/26/business/markets-debt-ceiling.html
https://home.treasury.gov/data/treasury-international-capital-tic-system
https://www.stcn.com/article/detail/983844.html
https://www.cbo.gov/publication/58946
Principles of Economics, 8th edition, 2021 — Robert H. Frank
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