In the early part of my career, I worked in government debt management, initially focusing on forecasting federal deficits and debt, and then later financing it through treasury bill and domestic and foreign debt issuance. This was during a period where inflation was rampant, and government spending was largely unchecked.
The current fiscal situation in the US mirrors challenges Canada faced in the 1990s. While not as severe, it is certainly becoming a challenge. For fiscal 2024 (ending September 30), the US budget deficit grew to $1.833 trillion—the highest outside of the COVID era—as interest on the federal debt exceeded $1 trillion for the first time, alongside rising spending for the Social Security retirement program, health care and the military. This marks an 8 per cent increase, or $138 billion, from the $1.695 trillion deficit recorded in fiscal 2023, making it the third-largest federal deficit in US history, following the pandemic-driven deficits of $3.132 trillion in 2020 and $2.772 trillion in 2021.
The primary driver of the year’s deficit was a 29 per cent increase in interest costs for Treasury debt, rising to $1.133 trillion due to a combination of higher interest rates and a larger debt load. Total interest costs exceeded expenditures for both the Medicare healthcare program for seniors and defense spending. As a share of GDP, interest costs reached 3.93 per cent, the highest since 1998, though still below the 1991 record of 4.69 per cent.
Will the deficit be any better under Harris or Trump? The Committee for a Responsible Federal Budget (CRFB) recently published an analysis of these campaigns. It estimates that Harris’ plan would increase the debt by US$3.5 trillion over a decade, relative to the Congressional Budget Office (CBO) baseline estimate, bringing it to 133 per cent of GDP by 2035. In contrast, Trump’s plan would boost the federal debt by $7.5 trillion over a decade, relative to the CBO baseline, taking the debt to 142 per cent of GDP. This estimate does not include the cost of making auto loans tax deductible, which could add another $400 billion to the federal debt over a decade, taking the total cost of Trump’s plan to $7.9 trillion.
What do these plans mean for inflation and interest rates? Both are expected to face significant challenges in Congress and are likely to change. However, the economy does not need fiscal stimulus; the unemployment rate has remained near 4 per cent for almost three years, indicating an economy at full employment. In such an economy, this extra demand wouldn’t add to output – it would add to inflation.
Any attempt to partially fund tax cuts through tariff increases would also fuel inflation through higher import costs, while the recessionary impact of retaliatory tariffs could slow the economy and erode the tax base. The Federal Reserve would likely respond to higher inflation by raising short-term interest rates, which would further slow the economy and increase net interest costs for the government.
While debts and deficits do not inherently cause inflation—governments often borrow and spend without producing inflation if they have credible repayment plans—our concern is continued struggles with fiscal discipline in the US could lead to future inflationary pressures. The November elections could worsen the outlook for federal finances, with the potential to inflict serious long-term damage on bonds and other markets. This scenario could lead to significantly higher interest rate levels than the 3.9 per cent average 10-year Treasury yield assumed in CBO baseline estimates.
While the Bank of Canada can deviate from the Fed if our monetary and fiscal policies are credible, fiscal mismanagement in the US will drag our yield curve higher, making it harder to see improvements in mortgage rates. Although it’s not an immediate concern, we don’t need the return of the bond vigilantes. As Bill Clinton’s political advisor James Carville famously said, “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”
Housing Affordability Watch
CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis
Government institutions often operate under the assumption of permanence, leading to a deep-seated resistance to change. This inertia hinders simple actions the federal government could take to improve housing finance and affordability in Canada. Our latest Housing Affordability Watch instalment explores these practical solutions, from enhancing the CMB program to updating tax policies. Learn how small steps can make a big difference. Read it here: Overcoming Inertia in the Housing Finance System
Independent Opinion
The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.
