Fiscal Policy

The Era of Fiscal Influence: Understanding the Shift in Economic Drivers

The financial system isn’t functioning the way it used to. Even with Trump’s pro-growth policies and DOGE’s push for spending cuts and efficiency, fiscal policy looks to remain the defining force in today’s economy. Government spending, debt, and deficits are steering the markets more than interest rates or private sector investment, and unfortunately, at this stage in the debt cycle, debt and spending are a core part of the system.

DOGE’s efforts to rein in spending could ease some pressure, but even the most aggressive budget cuts can’t change the fact that government spending has become deeply embedded in the economy. While Trump’s policies focus on growth, this long-term shift toward fiscal dominance is a challenge that has built up over decades and isn’t tied to any one administration.

Some might argue that cutting spending should slow down fiscal influence. Others might believe monetary policy (The Federal Reserve) should still be the primary force behind economic cycles. But looking at the numbers, it’s clear: the U.S. economy has structurally shifted toward government-driven liquidity, and both markets and policymakers are working within that reality, making inflation and government-driven liquidity a persistent theme for the decade ahead. However, persistence doesn’t mean crisis. Just as markets adapted to monetary policy control in the past, investors and businesses will find ways to navigate and thrive in this environment, even as fiscal policy now controls the pace of the game.

How We Got Here: From Free Markets to Central Banking

Before the creation of the Federal Reserve in 1913, the U.S. economy operated under a true free-market system, where the private sector determined supply and demand—not only for goods and services but also for money itself. Interest rates and lending were dictated by private banks and financial institutions, with market players and forces setting borrowing costs.

The creation of the Federal Reserve changed the game. Originally set up to keep the banking system stable, it quickly took on a much bigger role. During the Great Depression, the Fed stepped in with policies to help pull the economy out of the ditch. By the mid-20th century, managing inflation, jobs, and market liquidity became its main job, using monetary policy as its go-to tool.

Over the decades, each financial crisis led to greater reliance on central bank intervention. The 1970s stagflation crisis, the 1987 market crash, the 2008 financial crisis, and the COVID-19 recession all triggered aggressive Fed responses—whether through lower interest rates, Quantitative Easing (QE), or direct credit injections. As a result, markets became increasingly dependent on monetary policy decisions, with liquidity cycles tied directly to Fed actions.

By the late 20th century, Federal Reserve policy was the dominant force shaping economic conditions, with markets rising and falling based on changes in interest rates, QE, and liquidity injections.

That influence has only expanded. What was once a free market economy (where free markets determined supply and demand), became a monetary policy-driven economy (where the Fed played the largest role in shaping liquidity and financial conditions) has now shifted toward the government.

How Monetary Policy Used to Work

For most of late modern history, the Federal Reserve dictated the pace of economic growth and inflation through interest rate adjustments and liquidity injections.

• When the economy slowed down, the Fed lowered interest rates, making borrowing cheaper. This encouraged businesses to invest, consumers to spend, and asset prices to rise.

• When inflation rose too quickly, the Fed increased interest rates, making borrowing more expensive and slowing down spending to cool demand.

• During financial crises (like 2008 and 2020), the Fed implemented Quantitative Easing (QE)—buying government bonds and mortgage-backed securities to inject liquidity into the economy.

For decades, this system worked relatively well, with markets closely watching the Fed for guidance on interest rates and liquidity.

Under a government-led market, government spending, deficits, and debt issuance dictate liquidity more than central bank policy. Here’s some numbers that show the fiscal strain (and while it doesn’t mean doomsday) it does show why this situation will be hard to overcome by just one administration.

• Since 2020, federal debt has surged from $23.2T to over $36T—a 55% increase—while GDP grew from $21.5T to $29.7T, a 38% rise. With debt now exceeding 120% of GDP, history shows reversal becomes nearly impossible without austerity, inflation, or default. Reinhart and Rogoff’s Growth in a Time of Debt found that once debt surpasses 90% of GDP, growth slows, making repayment even harder. At this level, rising interest costs force borrowing more just to service debt, creating a cycle of perpetual deficits and monetary debasement. We went from debt being 35% of GDP in 1970 to 120% today.

• Net interest payments on the national debt have nearly tripled since 2020 as interest rates have risen:

• Since 2000, government debt (see purple section) as a percentage of total U.S. credit market debt has risen from 18% to over 40%, showing how federal borrowing has increasingly displaced private credit creation (the traditional driver of economic expansion).

• Over 70% of new Treasury issuance in 2023 was used just to cover interest payments and roll over existing debt, meaning much of the government’s borrowing is no longer fueling new economic activity but simply maintaining past obligations. Also, over 30% of all outstanding U.S. debt will need to be refinanced in the next three years, meaning rising borrowing costs will continue pressuring the federal budget.

• High interest rates, rather than slowing inflation, add more pressure to government finances, which leads to more deficit spending—more so fueling fiscal-driven liquidity. This debt burden of the government and new dynamic reduces the effectiveness of traditional monetary policy tools.

• If the Fed keeps rates high, borrowing costs rise, leading to higher government interest payments, which require more deficit spending to cover.

• If the Fed cuts rates, inflationary pressures could accelerate again, making it difficult to restore price stability.

This creates a policy paradox where monetary tightening is offset by continued fiscal expansion.

Inflation is likely to persist throughout this decade, though it may not spiral out of control if productivity gains, supply-side improvements, and measured fiscal adjustments help absorb some of the excess liquidity. However, the structural forces at play suggest that a return to the low-inflation environment of the past few decades will be very unlikely.