Fiscal Dominance and the Politicization of Money
Much of the contemporary debate about monetary policy focuses on technical questions: whether reserves should be scarce or abundant, whether fintech companies should have master accounts at the Federal Reserve, whether those accounts should resemble the accounts held by banks, or how far the Fed’s independence should extend. These are not unimportant questions. Yet these questions are secondary to the central issue shaping American monetary policy today: the fiscal needs of the federal government.
The United States government now runs deficits exceeding five percent of GDP annually, even outside periods of war or acute emergency.
Financing those deficits requires a constant mobilization of financial resources on a massive scale. Under such conditions, it becomes increasingly unrealistic to expect monetary policy to remain insulated from fiscal policy. The extraordinary politicization and centralization of monetary policy in recent decades is not an accident. It is evidence of fiscal dominance: the subordination of monetary policy to the borrowing requirements of the state.
Historically, central banking did not emerge 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 banking was the usefulness of monetary control to state finance. The Federal Reserve, like the Bank of England before it, ultimately serves as an institutional mechanism through which governments secure access to credit markets and maintain the liquidity necessary to fund public expenditures.
This reality becomes clearer once we understand the relationship between fiscal deficits, financial markets, and capital formation. Financial markets are not merely abstract mechanisms of liquidity. They represent claims on real wealth. Their depth and sophistication depend upon the existence of accumulated savings directed toward productive investment. Yet increasingly, the liquid savings of American society are not financing productive investment but the current consumption of the federal government.
When savings are directed toward entrepreneurial ventures, infrastructure, productive technology, or capital goods, society’s productive capacity expands. Additional wealth above what the current structure of production is able to produce is likely to be created in the future. But when savings are absorbed by chronic federal deficits, the resources represented by those savings are consumed rather than invested. Treasury securities may remain financially liquid and politically privileged, but economically they represent essentially claims on future taxation rather than claims on newly created productive wealth.
This is one reason why persistent fiscal deficits contribute not only to inflationary pressures but also to long-term stagnation. Financial markets may appear “deep” and highly liquid, while underneath the surface, the stock of productive capital formation weakens.
Jacques Rueff’s concept of “false rights” remains highly relevant here. This refers to when the political system creates claims on wealth without actually creating corresponding wealth. Monetary expansion and deficit finance allow governments to mobilize existing resources while obscuring the transfer from producers and savers to current public consumption.
Under these circumstances, it is pointless to hope for a depoliticized monetary order while fiscal irresponsibility continues unchecked. So long as the federal government depends on continuous large-scale borrowing, monetary institutions will inevitably be drawn into the management of public debt. The Federal Reserve may formally claim independence, but operational independence becomes increasingly fragile when the stability of public finances depends upon low interest rates, abundant liquidity, and orderly Treasury markets.
Evidently, I do not dispute the bona fide commitment of the recently appointed Chairman Warsh to Fed’s independence, or to sound money. My argument is about the constraints which he and his predecessor, for that matter, operate on.
Incidentally, this does not mean that all government monetary prerogatives are illegitimate. As I argued elsewhere, there are economic and moral reasons why a sovereign political society cannot entirely abdicate control over money and finance. The requirements of national defense create exceptional circumstances in which governments may need rapid access to resources beyond ordinary taxation. In moments of genuine emergency, a fiscal proviso exists. Political communities may temporarily subordinate monetary norms to survival.
But the norms appropriate for emergencies cannot become the ordinary principle of government. Ayn Rand once observed that we should not derive moral principles for normal human life from the conditions of survivors clinging to a raft after a shipwreck. The same principle applies to monetary institutions. Rules allowing for extraordinary powers that may be justified in wartime cannot become permanent features of peacetime governance, of our constitution, once the emergency has passed.
Ideally, the United States should recover the constitutional distinction between fiscal and monetary powers envisioned at the founding. Then, Congress was entrusted with the power of the purse and the responsibility for public finance. Monetary institutions were expected to support commerce and stable exchange, not permanently finance structural deficits. Restoring that separation would reduce the politicization of money and strengthen both democratic accountability and economic stability.
Yet such a restoration is impossible without fiscal prudence. Monetary reform without fiscal reform is an illusion. As long as the federal government systematically absorbs an ever-growing share of the nation’s liquid savings to finance current consumption, monetary policy will remain subordinate to fiscal necessity.
The path toward a healthier monetary order begins not with technical debates about reserve regimes or Fed governance, but with restoring discipline to the fiscal affairs of the American republic.
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Leonidas Zelmanovitz is a Senior Fellow with Liberty Fund and teaches part-time at Hillsdale College.
