Jay Powell says US needs to cut deficit ‘sooner rather than later’

The head of the Federal Reserve has warned the US economy is too strong to justify running such high deficits and urged Washington to address its fiscal imbalance “sooner rather than later”, in a sign of monetary policymakers’ rising concern about rampant government spending.

Jay Powell warned that the Biden administration was taking excessive risks by “running a very large deficit at a time when we are at full employment” and said “you can’t run these levels in good economic times for very long”.

The jobless rate in the world’s largest economy has not exceeded its current level of 4 per cent for more than two years, longer than at any time since Powell was “a teenager”, the Fed chair said on Tuesday.

Speaking at the European Central Bank’s conference in Sintra, Portugal, Powell said “the level of debt we have is completely sustainable but the path we are on is unsustainable”.

His comments came amid intensifying worries about debt levels as both President Joe Biden and Donald Trump are running on campaign pledges that seem unlikely to reduce the deficit whoever wins the November election.

Output in the US has grown at a faster pace than in other major advanced economies since the Covid-19 pandemic, but its fiscal deficit has remained larger than in G7 counterparts despite unemployment hovering close to record lows.

The Congressional Budget Office now expects this year’s US fiscal deficit to hit $1.9tn, or 7 per cent of GDP, up from a forecast of $1.5tn in February. It projects that the debt-to-GDP ratio will hit 122 per cent by 2034, easily surpassing the post-second world war record high of 106 per cent.

Concern is mounting over the US’s ballooning national debt, which is set to reach 99 per cent of GDP this year.

Trump’s plans to make his 2017 tax cuts permanent would add just under $5tn to deficits over the next 10 years.

People in Trump’s camp have threatened to replace Powell as Fed chair if he returned to the White House. Powell, however, said: “There is a very broad support for an independent Fed in both political parties on both sides of Capitol Hill . . . where it really matters.”

The Fed chair welcomed the recent fall in its preferred measure of US inflation to 2.6 per cent in May as “really good progress” but said it still wanted to see more evidence that price pressures and the labour market are cooling before it starts to cut interest rates. US borrowing costs fell slightly in response, with the yield on the 10-year Treasury down 3 basis points to 4.44 per cent.

Governments have ramped up their debt issuance in recent years as they spent vast sums supporting households and businesses in response to the pandemic and energy crisis following Russia’s full-scale invasion of Ukraine. 

But now central bankers worry politicians are being too slow to cut spending, which could threaten financial stability and keep inflation high.

ECB president Christine Lagarde only partially echoed Powell’s comments by stressing the need for governments in the EU to comply with the bloc’s reintroduced debt rules by reining in their deficits, while also urging them to support growth and productivity through targeted investment and structural reforms.

Financial markets have been spooked by the risk that France’s snap parliamentary election could deliver a far-right or far-left government that challenges the EU fiscal rules and increases spending sharply, risking a stand-off with investors and the bloc.

Lagarde declined to comment specifically on the election, saying: “The ECB has to do what it has to do,” while adding it was always “very attentive” to any threats to price stability.

Speaking on the same panel, Brazil’s central bank governor Roberto Campos Neto said high debt levels and elevated borrowing costs were starting to cause volatility in emerging markets. “It is time for us globally to think of a way to get some kind of stable trajectory of debt in the near future,” he said.