Debt Digest | The Fed’s Rule Problem
Links & Fiscal Facts
Here are this week’s reading links and fiscal facts:
Treasury Secretary nominee Bessent ignores entitlement challenge. In his confirmation hearing, Scott Bessent correctly noted that the “federal government has a significant spending problem.” Bessent suggested that in order to get our fiscal house in order, we must restrain the growth in discretionary spending. This is a desirable goal but one that will not prevent the coming fiscal crisis. Between 2025 and 2035, the Congressional Budget Office projects that discretionary programs will grow by $467 billion compared to the whopping $2.2 trillion in new mandatory spending. The cost growth in Social Security and Medicare almost exclusively drives future deficits. Reforming old-age retirement and health care programs is unavoidable—it is time to acknowledge it.
Social Security reform must address cost growth. As Charles Blahous explains in Discourse, Brookings’ new comprehensive reform proposal provides “a constructive Social Security plan at a time when we desperately need one.” However, “There is one large problem facing Social Security that the Brookings proposal as currently drafted wouldn’t solve. Under current law, Social Security costs are projected to grow relative to GDP by roughly 23% from now through the 2070s. That’s a problem because it translates into rising burdens on employment and economic production.” One straightforward fix is to tie the rate of benefit growth to price increases rather than wage growth, which I’ve written about here.
Bold ideas for a transformative Trump presidency. In his Substack, the Grumpy Economist, John Cochrane highlights a very ambitious growth, abundance, efficiency, and freedom agenda for the Trump administration. Here are a few highlights:
Replace the current income tax system with a consumption-based tax to simplify revenue collection and eliminate distortions caused by deductions and credits.
Streamline hundreds of means-tested programs into a unified system, ensuring no individual faces over a 50% marginal tax rate while incentivizing work and reducing costs.
Further health care market competition and innovation by removing market barriers like cross-subsidies, tax distortions, and licensing restrictions.
Establish mandatory reviews for regulations every 5–10 years, ensuring cost-benefit accountability and curbing the growth of ineffective rules.
Setting the record straight on BRAC. In an interview for Statecraft, Santi Ruiz and Diego Ruiz discuss the fundamentals behind the Base Realignment and Closure commission, including the promising idea of applying its best features to the Department of Government Efficiency. One error in their characterization of the BRAC process is the final say being an up-or-down vote. Instead, BRAC used a mechanism better described as congressional silent approval. “Forcing members of Congress to take an affirmative vote of approval […] poses a far larger barrier than allowing politicians to stand by as proposals get implemented in the absence of an affirmative act of disapproval.”
The Fed needs a monetary policy rule. With Trump declaring at Davos that he’ll “demand that interest rates drop immediately,” the need for a rules-based Federal Reserve has never been clearer. In a new policy analysis, Cato’s Jai Kedia and Norbert Michel test various monetary policy rules and compare them to the actual Federal Funds rate (see the graph below). As they note in a companion blog, “The key observation is that any of these policy rules would have helped the Fed avoid its costly post-pandemic mistakes. All rules recommended raising the FFR well before the Fed did so in early 2022. Instead, discretionary monetary policy led the Fed to incorrectly label inflation as “transitory” and its sluggishness in tightening its stance likely allowed inflation to become entrenched. Once it realized its mistake, the Fed had to execute a series of rapid rate hikes and has since kept its rate target higher than all the rules recommend. Had the Fed followed such a rule, it is likely that Americans may have experienced a stable increase in rates and avoided suffering the highest bout of inflation in at least 40 years.”
