Powell warns US budget is unsustainable.

The U.S. budget is on an unsustainable path, which makes it crucial for policymakers to deal with it sooner rather than later, Federal Reserve Chair Jerome Powell told senators on June 22.

During Powell’s testimony before the Senate Banking Committee about his semi-annual monetary policy report, several Republican senators pressed him on the federal budget and its effect on inflation.

Sen. Tim Scott (R-S.C.), the committee’s ranking Republican member, noted that the actions Congress takes “impacts significantly what you’ve had to do in order to slow down Biden’s absolutely explosive inflation.”

The central bank chief stopped short of critiquing fiscal policy, but he did concede that the federal budget “is on an unsustainable path.”

“It has been so for a long time. We need to deal with that sooner or later, and sooner is better than later. That’s about, but that’s what I can say, and that’s what essentially all of my predecessors have said,” Powell stated. “We are not charged with supervising fiscal policy in any way. It’s just as a high-level matter from the standpoint of the economy.”

In an exchange with Sen. John Kennedy (R-La.), Powell agreed that less government spending and fewer stimulus measures tend to be disinflationary. At the same time, he indicated a 10 percent reduction in federal spending could result in less demand and potentially slow the economy.

“Less demand would mean less economic activity, less spending, and that would have a negative effect on inflation,” Powell said.

After President Joe Biden signed the Fiscal Responsibility Act into law, the national debt topped $32 trillion for the first time, including $25 trillion in debt held by the public and about $7 trillion in intragovernmental debt. Following the signing, the U.S. government borrowed close to $400 billion in one business day.

Inflation and Interest Rates

Although inflation continues to run higher than the Fed’s goal, Powell does see a path of slowing price growth without substantial job losses. Fed officials do expect modest increases in the unemployment rates and gradual cooling, but “most of the loosening will come in the form of other ways.”

“Our part of it is to try to get inflation under control, and that’s what we’re doing,” he said. “Ideally, we’ll do that with as little as possible damage to the economy in the labor market.”

This was the second day of testimony for Powell, who appeared before the House Financial Services Committee on June 21. He told House lawmakers that more rate hikes are ahead. While inflation has cooled, it “remains well above” the central bank’s 2 percent target rate, indicating the policymakers have more work to do.

“Inflation has moderated somewhat since the middle of last year,” he said. “Nonetheless, inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go.”

Powell explained that lowering inflation will be achieved by slowing the U.S. economy to below-trend growth. But officials will continue to be data-dependent and make decisions on a meeting-by-meeting basis.

In May, the annual inflation rate slowed to 4 percent, down from 4.9 percent in April and below the consensus estimate of 4.1 percent. The core inflation rate, which strips the volatile energy and food sectors, eased to 5.3 percent, down from 5.5 percent.

“We have been seeing the effects of our policy tightening on demand in the most interest rate-sensitive sectors of the economy,” the Fed chief stated. “It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation.”

According to the CME FedWatch Tool, the futures market is mostly pricing in a quarter-point rate hike at next month’s Federal Open Market Committee (FOMC) policy meeting.

Last week, the Fed signaled two more rate increases this year, with the Survey of Economic Projections (SEP) showing that officials believe the median policy rate will climb to 5.6 percent from the March SEP of 5.1 percent. Officials also raised the benchmark fed funds rate expectation to 4.6 percent in 2024 from 4.3 percent in the March estimate.

What Other Fed Officials Are Saying

Many regional central bank leaders have been participating in interviews and delivering speeches since last week’s FOMC meeting. A common message among these officials is that they are concerned the institution will overshoot, meaning policymakers will raise interest rates too much and slow down the economy.