Reducing the $2T federal deficit could lower inflation, interest rates for Americans: CRFB

Curbing the federal government's roughly $2 trillion budget deficit would help reduce the affordability challenges American households are facing, a new analysis finds. The nonpartisan Committee for a Responsible Federal Budget (CRFB) published a report on Wednesday detailing how reducing the federal budget deficit over both the near- and long-term could improve affordability issues for Americans through fiscal policy changes involving tax and spending policies. CRFB finds that reducing the deficit can provide an affordability boost by tempering inflation, lowering interest rates, reducing cost pressures stemming from government policies, boosting private investment and preventing future affordability crises that could be caused by the insolvency of Social Security and Medicare.

"Conversely, expansionary fiscal policy – attempts to ease affordability concerns with subsidies, tax cuts, or spending measures financed by borrowed funds – is likely to worsen affordability challenges over time by boosting inflation, interest rates, and the cost of what is being subsidized," the group wrote.

CRFB said that fiscal policies geared toward deficit reduction, such as higher taxes or limited federal spending and transfers from the government to households, reduce excessive consumer spending and inflationary pressures facing households. Reducing inflation, which has been above the Federal Reserve's 2% target for five-and-a-half years and is currently about 3.4% year over year, can also give the central bank room to lower short-term interest rates.

"Deficit reduction lowers interest rates through two channels. First, lower deficits reduce inflationary pressure and thus make it easier for the Federal Reserve to cut short-term interest rates (or reduce the need for the Fed to increase interest rates). Second, a lower stock of debt reduces the interest rates the Treasury needs to offer on long-term debt in order to attract buyers," the report said.

Reducing federal deficits can reduce inflationary pressures that hit household budgets. CRFB noted that the Congressional Budget Office (CBO) estimates that every 1 percentage point reduction in debt-to-GDP ratio lowers interest rates by about 2 basis points. That means current interest rates are about 1.5 percentage points higher than they would be if the U.S. debt-to-GDP ratio was still at 2001 levels and hadn't tripled in the last 25 years.

Healthcare costs are a key area where government reforms within programs like Medicare and Medicaid can reduce both costs to the government and consumers. For example, CRFB noted policies to lower drug prices, reduce overpayments, and reform provider payments can lower premiums and coinsurance costs for Medicare enrollees. Lower federal deficits can also boost private investment, as CBO estimated that every dollar of federal borrowing "crowds out" about 33 cents of private investment – meaning firms invest less in areas that can boost productivity and workers' wages.