Drifting Toward Fiscal Dominance

Why America's mounting debt, political rhetoric, and quiet regulatory shifts suggest we are on a journey to fiscal dominance.

This week’s Macro Musings episode features Ben Harris, former Assistant Secretary for Economic Policy at the U.S. Treasury and now Vice President of Economic Studies at the Brookings Institution. Ben and I explored the United States’ deteriorating fiscal outlook, the risks of mounting debt, and the underlying structural forces behind our persistent primary budget deficits. In a conversation that ranged from budget math to the politics of fiscal denial, Ben brought the clarity of someone who has sat on both sides—inside Treasury during moments of crisis and now, from a think tank perch, trying to craft realistic solutions.

What made this episode especially timely is that just days after we recorded, President Trump signed the One Big Beautiful Bill (OBBB) into law on July 4, worsening the fiscal trajectory of the country. The OBBB is expected over the next decade to raise deficits $3-$4 trillion and push the debt-to-GDP ratio from its current value near 100% to about 124% The Committee for a Responsible Federal Budget (CRFB) notes that if the temporary provision in the bill become permanent then the debt burden rises to 130%.

The President of CRFB, Maya MacGuineas, did not hold her punches in commenting on this bill:

In a massive fiscal capitulation, Congress has passed the single most expensive, dishonest, and reckless budget reconciliation bill ever – and, it comes amidst an already alarming fiscal situation. Never before has a piece of legislation been jammed through with such disregard for our fiscal outlook, the budget process, and the impact it will have on the well-being of the country and future generations.

To be fair, the OBBB is not entirely without merit. One of its strengths is the permanent expensing of short-lived capital investments and domestic R&D, a policy that enhances neutrality in the tax code and encourages long-term investment. But these pro-growth provisions come at a steep cost: larger structural budget deficits that will, in turn, significantly increase the government’s interest burden. According to the CRFB, annual net interest payments are projected to rise from $1 trillion in 2025 to $1.9 trillion by 2034 under the new law.

These projections bring us one step closer to fiscal dominance. This is a state in which monetary policy becomes subordinated to the needs of government finance, undermining its primary mandate of price stability. Already, we are hearing rhetoric from political leaders that suggests this regime may be near. In the remainder of this newsletter, I want to highlight some of that rhetoric and explain why it should concern us. But first, here is a clip from my recent conversation with Ben Harris, where we discuss why the bond market may be the last line of defense and our final hope for restoring fiscal sanity.

The Fiscal Dominance Rhetoric is Growing Louder

Before looking at the growing rhetoric of fiscal dominance, it is worth pausing to clarify what the term actually means. Economists often frame the relationship between fiscal and monetary policy as a hierarchy: one authority leads, the other supports. In a regime of monetary dominance, the Fed actively targets inflation while fiscal policy passively ensures debt sustainability. But in a regime of fiscal dominance, that relationship reverses as fiscal policy actively determines inflation and the Fed passively keeps government finances afloat.

Fiscal dominance emerges when the government's debt and deficit levels become so large—and politically untouchable—that monetary policy must adjust to keep the government solvent. In this regime, the central bank is no longer free to fight inflation but is instead compelled to accommodate unsustainable fiscal paths, often through low interest rates or money creation. The table below, taken from my previous post on this topic, summarizes how these two regimes differ:

Now the threat of fiscal dominance comes not just from the rising debt, but in the way policymakers talk about the Fed. Recently, President Trump has shifted from criticizing Fed Chair Powell for not cutting rates for the sake of economic growth to complaining that high interest rates are driving up debt service. In effect, Trump is saying: the Fed is costing us too much money. That is the voice of fiscal dominance—the idea that monetary policy must serve fiscal constraints, not price stability. Below are some examples of this fiscal dominance rhetoric coming from President Trump:

It is worth noting that these posts do not just argue the Fed could be saving the U.S. government money. They also assert that there is “no inflation,” despite inflation still running above the Fed’s 2 percent target. This claim, in effect, serves as fiscal dominance rhetoric by implicitly pressuring the Fed to soften its inflation target. Here is a video from July 13 that nicely encapsulates all of this fiscal dominance rhetoric:

The fiscal dominance rhetoric, however, is not limited to just President Trump. It is bleeding into policy proposals—such as Senator Ted Cruz’s push to eliminate interest on reserves to save fiscal space—and even institutional design. Specifically, there has been discussion about Secretary Bessent becoming Fed Chair while also remaining Treasury Secretary Here is an excerpt from Bloomberg:

Trump’s advisers have even discussed with him the possibility that Scott Bessent could simultaneously serve as Treasury secretary and Fed chair, according to people familiar with the matter. Such a move would be unprecedented since the two roles were separated in 1935, in legislation aimed at giving the Fed a measure of independence.

This is not just symbolic. Combining these roles could weaken the post–1951 Fed-Treasury Accord, which gave the Fed operational independence to set monetary policy free from fiscal pressure. If this firewall collapses, the Fed could become subordinate to the Treasury.

So far, we have only seen rhetoric suggestive of fiscal dominance. But the very concern driving that rhetoric—soaring interest costs on the national debt—is poised to worsen significantly over the next decade. According to the CRFB, net interest payments are expected to nearly double, as shown below. As these costs mount, pressure on the Fed to lower interest rates will likely intensify. We may even begin to hear serious calls for the Fed to raise its inflation target to 3 or 4 percent in order to accommodate lower interest rates policies.

Fiscal Dominance Rhetoric as a Stage in a Journey?

To make better sense of where we may be heading, I want to highlight a recent framework developed by economist Olivier Jeanne in a paper titled From Fiscal Deadlock to Financial Repression: Anatomy of a Fall (NBER WP 33395). In it, Jeanne models what he calls “optimal financial repression”—a set of policies governments can use to avoid default when political gridlock prevents necessary fiscal adjustment. In this framework, financial repression unfolds in three sequential stages as debt levels rise and fiscal options narrow.

Each stage involves increasing distortion of the financial system to absorb government debt, beginning with relatively benign adjustments and ending with heavy-handed policies that subordinate monetary policy to fiscal needs. Jeanne emphasizes that while these stages are modeled as welfare-maximizing given constraints, they also reflect an erosion of central bank independence and a growing fiscal footprint in monetary operations.

The table below summarizes these three stages and shows how they map onto debt levels, policy mechanisms, and institutional tradeoffs.

Jeanne’s model estimates that Stage 2—the balance sheet financial repression stage—begins when government debt exceeds 100% of GDP, and banks begin absorbing more debt onto their balance sheets, typically financed by deposit expansion rather than crowding out private lending. This stage brings mild distortions, such as regulatory nudges or moral suasion, but monetary policy still retains formal independence.

Stage 2 is where the United States increasingly appears to be. With the passage of the OBBB, the U.S. debt-to-GDP ratio is poised to rise into the 100 - 120 percent range. At the same time, we are witnessing a wave of fiscal dominance rhetoric or moral suasion that implicitly calls for the Federal Reserve to accommodate this growing debt burden. These pressures are not yet mandates, but they are loud and growing. Additional evidence that we are operating within Stage 2 comes from expected regulatory changes to the Supplementary Leverage Ratio (SLR) and the emerging regulation of stablecoins. Adjustments to these frameworks—especially if designed to increase the financial system’s capacity to absorb Treasuries —function as indirect fiscal tools. They help the government fund deficits more easily without overt monetary financing.

We are not in Stage 3 where the Fed is forced to repress interest rates, buy up government debt, or soften its inflation target. But the political incentives are lining up. And Jeanne’s model offers a useful way to see this not as a binary shift, but as part of a progressive erosion of monetary dominance, with rhetoric, regulatory tweaks, and personnel decisions as early signals of the transition. Charles Calomiris offers up more details on what Stage 3 might look like.

Conclusion: The Road Ahead

The shift toward fiscal dominance is rarely declared outright. Instead, it creeps in, step by step, policy by policy, statement by statement. What Olivier Jeanne’s framework makes clear is that this shift is not necessarily sudden or dramatic. It unfolds gradually, often under the radar, as political incentives converge on the central bank and monetary policy becomes the path of least resistance for managing an untenable fiscal trajectory.

The United States is not in fiscal dominance yet. But the rhetoric is sharpening, the institutional firewalls are under discussion, and the regulatory architecture is bending in subtle ways to support growing deficits. If Jeanne is right, we are somewhere in Stage 2, drifting closer to a world in which the Fed is no longer free to prioritize price stability.

Whether we move further down that path—or push for a return to fiscal discipline and institutional independence—depends on the political choices we make now. That is why this conversation matters. It is not just about the debt; it’s about the design and durability of the economic framework that supports our democracy.

Stay tuned, and stay watchful.