Federal Reserve Chair Kevin Warsh reaffirmed on July 29 that the central bank has no room to soften its 2% inflation target, even as U.S. gross national debt has climbed to about 120% of GDP. The country carried a similarly large debt load after World War II and escaped it only through sustained inflation, not economic growth. President Trump said Monday he had briefly spoken with Warsh, who Trump said must still work with the Fed's board of governors.
Warsh holds the line on 2%
Speaking at his July 29 press conference, Warsh said: "There's only a target, and it's 2%." Bond markets appear to take him at his word: the gap between regular and inflation-protected Treasury yields currently implies investors expect inflation to average about 2.25% over the next decade.
Yet inflation has averaged 4.2% over the past five years. Consumer prices have also risen 3.5% over the past 12 months, leaving Warsh's target well below the recent trend.
A debt load last seen in 1945
That gap matters because of the debt sitting behind it. At the start of the millennium, gross national debt stood at about 55% of GDP. It climbed to 62% in 2007, just before the global financial crisis. Debt has since reached about 120% of GDP. Looking further out, the Congressional Budget Office expects annual deficits to climb to nearly 7% of GDP by 2036. That trajectory would push debt toward around 140% of GDP.
Washington last carried comparable debt after World War II, when it relied on inflation that averaged 4.7% a year between 1945 and 1981. Meanwhile, 10-year Treasury notes paid only 2.8% a year on average. As a result, bondholders lost about 50% of their money in real terms over that stretch. Federal budgets also ran surpluses in seven of the 13 years between 1947 and 1960 — a discipline absent today. Last year's deficit alone reached 5.8% of GDP.
Trump says he checked in with Warsh
Separately, President Trump said Monday he had spoken with Warsh a few days earlier, calling it a brief exchange. Trump added that Warsh will run the Fed, but that decision-making power ultimately rests with the board of governors he must work alongside.
Inflation-protected Treasury bonds, known as TIPS, currently let investors lock in real interest rates as high as 3% a year.
Sources: MarketWatch.com – Top Stories, Economy News
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