Fiscal control and the politicization of money
Much of the contemporary debate about monetary policy focuses on technical questions, such as whether reserves should be scarce or abundant, whether fintech companies should have master accounts at the Federal Reserve and whether those accounts should resemble those held by banks, or how far the Fed’s independence should extend. These are not unimportant questions. But these questions are secondary to the central issue shaping American monetary policy today: the fiscal needs of the federal government.
The U.S. government currently runs deficits of more than 5% of GDP each year, even outside of periods of war or emergency.
Financing these deficits will require the continued mobilization of large financial resources. Under these circumstances, it becomes increasingly unrealistic to expect monetary policy to remain separate from fiscal policy. The extraordinary politicization and centralization of monetary policy in recent decades is no coincidence. This is evidence of fiscal domination and the subordination of monetary policy to national borrowing requirements.
Historically, central banks were not created primarily to stabilize prices or fine-tune economic fluctuations. Central banks emerged as instruments of public finance. As Vera Smith observed long ago, the most powerful reason for government intervention in banks was the usefulness of financial regulation to national finances. The Federal Reserve, like the Bank of England before it, ultimately serves as an institutional mechanism for governments to ensure access to credit markets and maintain the liquidity needed to fund public spending.
This reality becomes clearer when we understand the relationship between fiscal deficits, financial markets, and capital formation. Financial markets are not just abstract mechanisms of liquidity. They represent claims about actual wealth. Its depth and sophistication depend on the existence of accumulated savings directed towards productive investments. But rather than funding productive investment, American society’s liquidity savings are now funding the federal government’s current consumption.
When savings are channeled into entrepreneurial ventures, infrastructure, production technologies, or capital goods, a society’s productive capacity is expanded. Further wealth may be created in the future than the current production structure can generate. But when savings are absorbed by chronic federal deficits, the resources represented by those savings are consumed rather than invested. Treasury securities may still be fiscally liquid and politically privileged, but economically they essentially represent a claim against future taxation rather than a claim on newly created productive wealth.
This is one reason why persistent budget deficits contribute not only to inflationary pressures but also to secular stagnation. Although financial markets appear “deep” and liquid, behind the scenes the stock of productive capital formation is weakening.
Jacques Rueff’s concept of “false rights” remains very important here. This refers to political systems creating rights to wealth without actually creating the corresponding wealth. Monetary expansion and deficit financing allow governments to mobilize existing resources while obscuring transfers from producers and savers to current national consumption.
In such a situation, it is pointless to expect a depoliticized financial order as fiscal irresponsibility remains unchecked. As long as the federal government relies on continued large-scale borrowing, financial institutions will inevitably be drawn into managing public debt. The Fed may formally claim independence, but its operational independence becomes increasingly fragile when fiscal stability depends on low interest rates, abundant liquidity, and orderly Treasury markets.
Obviously, I do not dispute that recently appointed Chairman Warsh is sincerely committed to Fed independence and fiscal health. My argument is more about the constraints he and his predecessors are working with.
By the way, this does not mean that all government monetary privileges are illegal. As I have argued elsewhere, there are economic and moral reasons why sovereign political societies cannot completely relinquish control over money and finance. National defense requirements create exceptional circumstances in which governments need rapid access to resources beyond normal taxation. In times of real emergency, there is a proviso prosecutor. Political communities may temporarily prioritize monetary norms for survival.
But norms appropriate for emergencies cannot become ordinary principles of government. Ayn Rand once said that moral principles for normal human life should not be derived from the situation of survivors clinging to a raft after a shipwreck. The same principle applies to financial institutions. Rules granting extraordinary powers that might be justified in times of war cannot become permanent features of peacetime governance or the constitution once the emergency has passed.
Ideally, the United States should restore the constitutional distinction between fiscal and monetary power as envisioned at the nation’s founding. Congress was then entrusted with the power of the purse and responsibility for finances. Financial institutions were expected to support commerce and a stable exchange rate, rather than permanently financing structural deficits. Restoring this separation would reduce the politicization of money and strengthen both democratic accountability and economic stability.
But without fiscal prudence, such a recovery will not be possible. Financial reform without fiscal reform is an illusion. As long as the federal government systematically absorbs an ever-increasing share of the nation’s liquid savings to finance current consumption, monetary policy will continue to be subordinated to fiscal necessity.
The path to a healthier financial order begins with restoring discipline to the finances of the American Republic, not with technical debates about reserve systems or Fed governance.
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Leonidas Zelmanowitz is a senior fellow at the Liberty Foundation and an adjunct instructor at Hillsdale College.
