This week on Facing the Future, host Bob Bixby spoke with Gordon Gray, Vice President of Budget Analysis at the Peter G. Peterson Foundation, to provide a status update on the federal budget as the fiscal year nears its end. Gray also discussed the economic effects of the growing debt, the complexities of tariff revenues, and the dysfunction of the budget process.
Gray noted that the budget is “running hotter than last year, and will probably hit about $2 trillion for the fiscal year. When all is said and done, the highlight, or lowlight, is that we’re likely to spend a trillion dollars on interest for the first time, ever. It will likely end up as the second largest federal expenditure, second only to Social Security, so it has now durably eclipsed both defense and Medicare. And, that is probably the most frightening evolution, budgetarily, that I’ve seen since I’ve watched the budget.The interest rate environment has materially changed in the last five years and we have only indirect control over our interest costs, whereas we can control what Congress spends, and we can, as hard as it may be, raise taxes and change benefit programs. So that’s the real flashing red light on the dashboard for me.”
Gray estimated that the total national debt is likely to hit $40 trillion sooner than had been projected. He said that earlier this year, the debt was expected to hit $40 trillion later this fall. Now, however, as a result of higher interest, lower tariff revenues and “borrowing a lot,” he said the debt is already “pretty close” to that level, within about $300 billion.”
The budget process itself is far behind schedule. Congress has not passed a budget resolution, which was supposed to be done by April 15, and none of the 12 annual appropriation bills have been completed. Instead, House and Senate members are already negotiating a continuing resolution (CR) to keep the government funded on a temporary basis when the new fiscal year begins in October. “I think it is the case that since the Congressional Budget Act of 1974 established what has become the, quote, modern budget process – I use quotes, because it’s not a process, it’s a series of outcomes that does not map well against what Congress had originally intended – I believe it is the case that In the years since, ‘74, roughly 50 years, the process has been followed four times, fully into completion. So, that train went off the rails pretty quick.”
Right now, we are… we are headed towards, $3 trillion deficits, in the next 10 years, $2 trillion of those deficits will be interest costs, so we’re essentially, putting, the interest costs from one credit card onto another, and there’s no, no, no creditor would look at that individual doing that and say, oh, you’re credit worthy. We’ve had, you know, the major credit rating the path that we are on. So, Congress will have to step in and make choices. Indeed, Social Security is expected to be exhausted in 2032. That means if you’re running for the Senate right now, it’s gonna be on your watch, so you can’t avoid that hard choice. I think a lot of members have: come and gone without ever really having to take too much of a hard vote on this. They just sort of add to the deficit, do their time, and leave. And this next cohort of senators are gonna have a real problem that they’re gonna have to really fix.”
Looking at the broader economic picture, Gray connected the federal debt to everyday financial impacts. He emphasized that “Mortgages are matched pretty closely against the 10-year treasury rate. There’s a spread, so essentially the interest rate on a mortgage is about 1.5% to 2% higher than the 10-year, but the relationship is fairly stable with that spread in place. And so, to the extent that the debt pushes up interest rates – and there’s a whole literature in economics research that as the debt goes up there’s upper pressure on interest rates – then that funnels directly into household finance. Over the life of the loan, it can really add up to tens of thousands of dollars for a mortgage and a few hundred bucks in your monthly car payment. It really matters.”
Gray further explored the complex relationship between high federal debt and inflation. He explained, “When we look at economies that are heavily indebted, you can get into a cycle of fiscal dominance where the monetary authority, the central bank, essentially has to buy the government’s debt. There are a lot of real-world examples of when countries that have high debt often have high inflation. It de-anchors the inflation expectation, and in buying the government’s debt, it expands the monetary supply.” This cycle can lead to persistent inflation, posing a dilemma for the Federal Reserve, which must balance fighting inflation with pressures to support fiscal policy.
Gray described a condition known as fiscal dominance, “where fiscal factors dominate monetary policy, even at the central bank; where if conditions warranted, they would otherwise want to raise interest rates, but if you’re heavily indebted, and you’re buried in interest costs, you want your central bank to keep interest rates low so that your interest costs aren’t swamping everything else. But what does that do? That leaves them more susceptible to inflation, and you get this vicious cycle.”
Reflecting on historical precedents, Gray notes, “What we saw in the 60s and 70s was inflation shot through the roof and was allowed to basically stay there, and so everybody just readjusted their inflation expectations.” He warns that if inflation expectations become de-anchored again, it could lead to a self-reinforcing cycle of higher inflation that undermines decades of progress.
Gray stressed that real solutions will require political will and informed public engagement. Addressing the challenge of fiscal sustainability, he said, “Basically, fundamentally, the American people have been convinced of the notion that they can have all the government they want without paying the taxes to fund it. And our elected officials have contributed to that. But ultimately, unless and until we prevail upon the American people to elect people who are willing to make hard choices and raise our taxes and cut spending to right the ship, this will persist.” He underscored the importance of voters and candidates understanding the stakes, especially concerning programs like Social Security, which will inevitably be part of future negotiations.
