Feeling the Squeeze? It Might Be the High Price of Ignoring the Deficit

This week’s release of the latest Consumer Price Indices underscores the one issue area where polls consistently show President Trump performing particularly badly. It isn’t immigration, it isn’t trade, and it isn’t even the overall handling of the economy. It’s the cost of living, or inflation.

The president’s net approval rating on the first three issues ranges from −5 percent to −17 percent. On inflation, voters give the president a net approval of −28 percent, with nearly two-thirds disapproving. It’s easy to see why. Year-over-year inflation, stuck at 2.7 percent as of November, remains well above the Federal Reserve’s target of 2 percent.

The underlying drivers of that inflation remain cause for concern today -- namely, out-of-control deficits and a rapidly growing national debt.

Household survey data indicate that consumers are expecting this pain to continue for some time. They expect inflation to be above 3 percent a year from now. Undoubtedly, some of these expectations can be explained by temporary cost increases driven by tariffs, which have pushed household costs up by between $1,100 and $1,700 per year on average. More fundamentally, though, consumers and businesses are still reeling from the Biden-era inflation spike of 2021–24, which was fueled by an enormous deficit-financed spending spree.

That’s why they should be worried that, in the past six months alone, national debt held by the public has increased by nearly $2 trillion. In the first two months of fiscal year 2026, the government spent $1.62 for every $1 it collected in taxes.

All this federal borrowing signals to bondholders that the government has no serious plan to pay them back with future surpluses. Under the fiscal theory of the price level, prices must adjust until the real value of public debt equals the present value of expected future surpluses. In other words, as policymakers fail to rein in spending or raise necessary revenues to cover the cost of our bloated government, fiscal payback instead takes the form of higher prices, which erodes the real value of government debt.

Anticipating this loss of purchasing power, firms raise prices today, generating inflation, while investors demand higher nominal yields, reinforcing expectations that today’s dollars will be worth less in the future.

To make matters worse, the Federal Reserve -- which has a mandate to keep inflation stable -- at this point appears to be sliding toward a cycle of “fiscal dominance,” in which loose monetary policy serves to enable yawning deficits. Far from keeping inflation low, it is now actively fueling inflation.

In addition to cutting interest rates by 175 basis points over the past 15 months -- an act of expansionary monetary policy typically used to induce higher output and inflation — the Fed is now buying $40 billion of U.S. short-term treasury debt every month.

By absorbing about a quarter of all newly issued debt going forward, the Fed is enabling, if not actively encouraging, the federal government to continue in its profligacy.

Unlike when the private sector buys Treasuries, the Fed’s purchases are financed by creating new base money for banks to send out into the wider economy, ultimately eroding the value of the dollars in your pocket. What’s more, large-scale asset purchases could ease financial conditions by signaling that policy rates will stay low for longer by flooding money markets with reserves, putting downward pressure on short-term interest rates.

Even if Chairman Powell and other Fed officials insist that bond purchases are a technical fix to maintain ample reserves, it doesn’t change the fact that investors will perceive the move as dovish, easing financial conditions through the expectations channel. Altogether, the Fed is adding fuel to an inflationary fire. Whether this is a real-time example of fiscal dominance or not, the outcomes are likely to be the same: higher prices.

So, what is Congress doing to address the underlying fiscal drivers of these inflationary pressures?

Far from working to quell the fiscal profligacy that forces inflation higher, Democratic policymakers are currently pushing to expand temporary Covid-19 subsidies at a cost of $635 billion over 10 years. Meanwhile, the president is showering farmers with billions of dollars in bailout funds as his tariff regime continues to pour cold water on foreign demand for U.S. crop exports.

Absent serious efforts to tackle the long-term, structural drivers of our fiscal imbalance -- Medicare, Medicaid, and Social Security -- inflation is likely to remain stubbornly high and persistent into 2026 and beyond, which brings us back to the cost of living. That is the issue that will likely decide the outcome of the 2026 midterm elections.

Inflation will not subside if policymakers don’t make a genuine attempt at reducing the trajectory of our deficits and debt, thereby boosting the confidence of bondholders that they will be repaid. Faddish proposals for price caps and other distortionary interventions will only make a bad situation worse by creating shortages and deterring investment.

If the inflation surge of the last few years taught us anything, it is that nothing topples a government’s political standing faster than rising prices. Unless policymakers change course, voters will once again make their discontent unmistakably clear.