An American central bank that lacks operational autonomy could tip the US into a fiscal crisis

Several factors are at play.

First, the US population is ageing. The number of retirees will grow quickly as the baby boomer generation retires, increasing the cost of Medicare and Social Security spending. At the same time, America’s crackdown on immigration and falling fertility rates will cause the number of workers to stagnant.

Second, last year’s One Big Beautiful Bill Act (OBBBA) reduced corporate and personal income tax revenue considerably more than it cut spending. The CBO projects the OBBBA will boost the US deficit by $4.7 trillion over 10 years.

The CBO estimated this will be partially offset by $3 trillion in revenue generated by higher tariffs, but the forecast may be too optimistic after the US Supreme Court ruled that tariffs enacted under the International Emergency Economic Powers Act (IEEPA) were illegal; the revenue raised under that authority needs to be refunded.

Although the Trump administration has vowed to replace this lost revenue with new tariffs, the legislative authority that is available to do so is limited.

For example, the 10% across-the-board tariffs the administration imposed using its Section 122 authority, which allows the president to impose tariffs to address “balance-of-payments deficits,” has not been used before. Moreover, this authority is temporary, only lasting for 150 days unless extended by Congress. Similarly, levies imposed under Section 301 authority—sector-specific tariffs against countries engaged in unfair trade practices—are not broad-based and require formal investigations and findings before they can be implemented.

Third, the CBO’s defence spending projections are likely to be much too low. Even before the US-Israeli war with Iran commenced, US President Donald Trump was seeking to increase defence spending in fiscal 2026-27 to $1.5 trillion, up from $893 billion in fiscal 2024-25. In contrast, the CBO assumes defence spending in fiscal 2026-27 will only be 1% higher than in 2024-25. Moreover, the war will undoubtedly generate additional costs. The Center for Strategic and International Studies estimates the conflict is costing the US about $1 billion per day.

Fourth, the CBO projects debt service will reach 4.6% of GDP in 2036, up from 3.3% in 2026. Large budget deficits are increasing the amount of federal debt and the interest expense needed to service the shortfall. In addition, the average interest rate on the debt continues to rise as the low-cost debt issued between 2009 and 2022 matures and is refinanced at higher interest rates.

The debt service problem is one reason why the Trump administration seems intent on seizing control of the Federal Reserve and cutting short-term interest rates. Lower rates help the fiscal outlook in three ways: lower debt service costs, faster economic growth that generates more tax revenue and faster inflation that reduces the real debt burden.

Over the next decade, the CBO expects there will be a 2 percentage-point gap between the annual budget deficit (6%) and nominal GDP growth (4%). Consequently, the federal debt-to-GDP ratio will rise by about 2% each year. But if growth and inflation were each a percentage higher, then nominal GDP growth would be 6%.

Wouldn’t that solve the fiscal sustainability problem? Unfortunately, not in practice. First, any acceleration in the pace of economic growth would be short-lived as the economy ultimately hits its resource limits. Perhaps AI could relax those constraints, but that is highly speculative at this point. The CBO already includes the impact of AI on productivity growth in its estimates, but it is small. The CBO assumes AI will only boost productivity growth by about 0.1% each year.

Second, if the inflation rate rose and the Fed’s independence were compromised, inflation expectations would increase, pushing up yields on longer-dated Treasury securities as well as the government’s debt service costs.

As the economist Herb Stein observed, “If something cannot go on forever, it will stop.” Markets are ignoring the nation’s increasingly unsustainable fiscal path and the absence of political will to tackle it.

If the Fed’s independence is compromised, that could be the trigger that brings bond market vigilantes back, and, with them, the sort of market turbulence that would force the US administration and Congress to change course. ©Bloomberg

The author is a Bloomberg Opinion columnist.