The Fed’s Inescapable Crisis: How Fiscal Dominance Is Straining Monetary Policy in 2025

The Federal Reserve’s balancing act just got harder. Fiscal dominance—the tail wagging the monetary policy dog—is tightening its grip, forcing the Fed into a corner with no easy exits.

Why the Fed Can’t Win

Soaring deficits, political pressure, and market volatility are colliding. The central bank’s toolkit looks increasingly outdated as fiscal policy hijacks the economic steering wheel.

The Inflation Trap

Printing money to fund debt? Check. Delayed rate cuts to avoid spooking Congress? Double-check. The Fed’s independence is eroding faster than the dollar’s purchasing power.

A Cynic’s Take

Meanwhile, Wall Street shrugs—another day, another distortion to trade. After all, what’s a central bank for if not to clean up fiscal messes with cheap liquidity?

The fast-rising blue line above may now be the biggest budgetary problem.

This puts the Fed in a bind because raising interest rates to encourage fiscal sanity would only exacerbate the problem it wants lawmakers to address.

The Fed could risk it, of course. 

But if rate hikes drive the deficit even higher, who blinks first: the Fed or the White House?

Before answering, consider that 73% of federal spending is now non-discretionary, vs. just 45% in the 1980s.

To believe the Fed can win a showdown over deficits is to believe Congress will make significant cuts to non-discretionary spending like Social Security and Medicare.

This seems, well, unbelievable. 

Now, especially, with a president who appears wholly unperturbed by the country’s growing indebtedness.

This may come from his experience as an over-indebted real estate developer in the 1990s.

“I figured it was the bank’s problem, not mine,” Trump later wrote of not being able to service his debts. “What the hell did I care? I actually told one bank, ‘I told you you shouldn’t have loaned me that money. I told you that goddamn deal was no good.'”

Now, as president, when Trump tells Powell that interest rates should be lower, what he’s really saying is that the national debt is the Fed’s problem, not his.

He’s not wrong. 

“When interest payments on the debt rise and primary surpluses are politically off the table,” David Beckworth writes, “something else has to give. That something is more debt, more money creation, or both.”

Yes, the Fed could run the Volcker/Greenspan playbook and threaten Congress with higher interest rates.

But Powell presumably knows that following through would only exacerbate a problem that might ultimately be the Fed’s to fix — and pull forward the time by which it’s forced to fix it.

“If debt levels are too high and growing,” Beckworth explains, “it becomes the Fed’s job to accommodate — by suppressing interest rates or monetizing debt.” 

That, and not President Trump, he warns, is the real existential threat to the Fed: “When the central bank is forced to accommodate fiscal needs, it loses its economic independence.” 

Beckworth remains hopeful that it might not come to that. 

And maybe it won’t. We’ve just seen how unpopular inflation is, so maybe if we get another bout of it, voters will force lawmakers to address the deficit.

But he despairs that the focus on Trump’s demands for lower interest rates is a distraction: “What we are witnessing is less about Trump himself and more about the growing and unavoidable fiscal demands being placed on the Fed.”

President Trump is the first to start explicitly making those demands, presumably because he knows the US government’s current fiscal policy is unsustainable. 

But everyone knows that, even the government itself.

The only question now is: Who’s going to deal with it?

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