Having served as both Treasury Secretary and Federal Reserve Chair, Yellen warns: "Fiscal dominance" threatens the U.S. economy

The continuously rising federal debt in the United States is pushing the country's economy to the brink of danger. Former U.S. Treasury Secretary and former Federal Reserve Chair Janet Yellen warned that a scenario known as "fiscal dominance" is brewing, where the massive scale of debt may force the central bank to keep interest rates low to reduce debt servicing costs, rather than focusing on curbing inflation.

On January 5th, Bloomberg reported that Yellen stated at the American Economic Association annual meeting held in Philadelphia last Sunday (January 4th), "The preconditions for 'fiscal dominance' are clearly strengthening." She specifically pointed out that Trump has "publicly called" for the Federal Reserve to lower interest rates, with the explicit aim of reducing government debt servicing expenditures. If such political pressure forces the central bank to compromise, the independence of U.S. economic governance will face severe challenges.

The report noted that this warning was echoed by several heavyweight economists present at the event. Former Cleveland Fed President Loretta Mester bluntly stated, "The most concerning aspect of the current debt issue is that officials in the Trump administration seem unaware of the threat." She pointed out that unlike previous administrations that, even when ineffective, were acutely aware of their precarious situation, the current administration may not recognize the severity of the potential consequences at all.

The Congressional Budget Office (CBO) projects that this year's federal deficit will reach $1.9 trillion, with the total debt-to-GDP ratio rising to around 100%, and further climbing to about 118% over the next decade. This unsustainable debt trajectory not only exacerbates fiscal risks but also places monetary policymakers in an unprecedented dilemma.

The report also noted that despite the grim outlook, Yellen retains a cautious optimism for the future, believing that the potential crisis could serve as a catalyst, forcing Congress to ultimately reach a bipartisan agreement to implement necessary budget reforms.

Intensifying Fiscal Dominance Risks

Yellen's core concern is that monetary policy succumbs to fiscal pressure. "Fiscal dominance" refers to a situation where, when sovereign debt reaches unsustainable levels, fiscal policy effectively takes over the macroeconomic leadership. In this scenario, the central bank loses its independence and is compelled to artificially lower interest rates to ensure the government can service its debt, thereby abandoning its primary responsibility of controlling inflation.

According to reports, Yellen had previously expressed more severe concerns, stating that if Trump successfully pressures the Federal Reserve to maintain low interest rates to alleviate the government's debt burden, the U.S. could face the danger of becoming a "banana republic." In last Sunday’s discussion, she reiterated her concerns about Trump's pressure on the Federal Reserve, believing that such political interference is reinforcing the preconditions for fiscal dominance to occur.

In addition to the sheer scale of the debt, cognitive biases among decision-makers are seen as another significant hidden danger. Mester emphasized during the panel discussion that the most "terrifying" part of the current situation is the current administration's lack of understanding of the risks. "Previous administrations knew they were on the edge of a cliff, but I believe this administration may not realize the implications." Analysis suggests that this lack of awareness may lead to misjudgments in policy-making, thereby accelerating the deterioration of the fiscal situation.

The Possibility of Crisis Driving Reform

Despite the grim outlook, Yellen remains cautiously optimistic about the future.

She stated that potential crises—such as the impending bankruptcy risks facing Social Security and Medicare—could serve as catalysts, forcing Congress to ultimately reach a bipartisan agreement to implement necessary budget reforms.

Not all economists at the meeting share Yellen's hope. David Romer, an economist at the University of California, Berkeley, expressed that he is "less optimistic" about the prospect of a bipartisan agreement to avoid a "fiscal disaster." Romer warned:

"We are facing fiscal issues. If we do not address this problem, it will trouble everyone, including the Federal Reserve."

Analysts point out that this viewpoint highlights the academic community's deep concerns about the long-term fiscal health of the United States and its spillover effects on monetary policy. As the debt-to-GDP ratio approaches 118%, the time window for policymakers to address the issue through conventional means is narrowing