Rising Rates Are Complicating Fiscal Policy

There’s an old joke about a patient who wakes up in the hospital after an operation. The doctor walks in and tells him he is going to live. In the next moment, though, the surgeon shares the bill for his services. The patient asks, “Is there any good news?”

The global economy has faced two heart-stopping events since 2020: first, the pandemic; then, the Russian invasion of Ukraine. Both have taken a significant humanitarian and financial toll. To aid in recovering from these situations, governments around the world have spent immense sums of money; more may be necessary to ensure a full recovery. The bills for the operation are coming due, though, and the carrying costs of financing them are rising.

Nations have accumulated immense amounts of debt during the past half-century. Classically, fiscal expansion is used to counteract shocks to private demand, such as those associated with war, natural disasters, or recessions. But since the 1980s, it has become much more common for countries to run deficits even during times of peace and prosperity.

Progressives have always favored using government to achieve a range of societal goals, while conservatives adopted a supply-side, tax-cutting approach to economic policy in the early 1980s. The two sides rarely agreed on legislation, but they generally agreed that deficits weren’t a concern…and made little effort to contain them. Borrowing grew gradually, and then substantially after the challenges of 2008 and 2020.

Financing these endeavors has been facilitated by a seemingly boundless appetite among investors for sovereign debt. With rare exceptions, auctions of government paper are enthusiastically received; international investors are often heavy buyers. Carrying costs have generally been modest for most countries, enabling them to go further and further into debt.