The Federal Reserve’s policies of increasing interest rates and quantitative tightening—reducing its $8.9 trillion balance sheet—will increase the volume and cost of federal government borrowing, slamming the federal budget and exposing the consequences of decades of deficit spending.
The impact will be felt even without a recession, but if the economy does contract, the government will have limited capacity to spur a recovery with fiscal stimulus.
Since February 2020, publicly held U.S. Treasury debt has exploded, growing from about $17 trillion to $24 trillion. Almost half of the increase has wound up at the Fed, whose Treasury holdings have ballooned from $2.5 trillion in February 2020 to $5.8 trillion.
Quantitative tightening is a big initiative. In May the Fed announced plans to reduce its Treasury holdings by $330 billion by the end of the year, and by $720 billion annually thereafter until its balance sheet shrinks to a yet-to-be-determined size. The Fed can reduce its balance sheet, but that doesn’t mean the federal government can reduce its balance of outstanding debt.