Deficit reduction could lower inflation and interest rates, CRFB finds

Curbing the federal government’s roughly $2 trillion budget deficit would help reduce the affordability challenges American households are facing, a new analysis finds.

The nonpartisan Committee for a Responsible Federal Budget (CRFB) published a report on Wednesday detailing how reducing the federal budget deficit over both the near- and long-term could improve affordability issues for Americans through fiscal policy changes involving tax and spending policies.

CRFB finds that reducing the deficit can provide an affordability boost by tempering inflation, lowering interest rates, reducing cost pressures stemming from government policies, boosting private investment and preventing future affordability crises that could be caused by the insolvency of Social Security and Medicare.

“Fiscal policy alone cannot solve all affordability challenges,” CRFB noted, adding that monetary policy, regulation, plus policies related to housing, trade, foreign, labor and education are also significant factors, including at the state and local level. “But responsible fiscal policy can play an important role.”

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The federal government is running a roughly $2 trillion budget deficit this fiscal year. (J. David Ake/Getty Images)

“Conversely, expansionary fiscal policy – attempts to ease affordability concerns with subsidies, tax cuts, or spending measures financed by borrowed funds – is likely to worsen affordability challenges over time by boosting inflation, interest rates, and the cost of what is being subsidized,” the group wrote.

CRFB said that fiscal policies geared toward deficit reduction, such as higher taxes or limited federal spending and transfers from the government to households, reduce excessive consumer spending and inflationary pressures facing households.

Reducing inflation, which has been above the Federal Reserve’s 2% target for five-and-a-half years and is currently about 3.4% year over year, can also give the central bank room to lower short-term interest rates.

“Deficit reduction lowers interest rates through two channels. First, lower deficits reduce inflationary pressure and thus make it easier for the Federal Reserve to cut short-term interest rates (or reduce the need for the Fed to increase interest rates). Second, a lower stock of debt reduces the interest rates the Treasury needs to offer on long-term debt in order to attract buyers,” the report said.

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Reducing federal deficits can reduce inflationary pressures that hit household budgets. (Spencer Platt/Getty Images)

CRFB noted that the Congressional Budget Office (CBO) estimates that every 1 percentage point reduction in debt-to-GDP ratio lowers interest rates by about 2 basis points. That means current interest rates are about 1.5 percentage points higher than they would be if the U.S. debt-to-GDP ratio was still at 2001 levels and hadn’t tripled in the last 25 years.

Healthcare costs are a key area where government reforms within programs like Medicare and Medicaid can reduce both costs to the government and consumers. For example, CRFB noted policies to lower drug prices, reduce overpayments, and reform provider payments can lower premiums and coinsurance costs for Medicare enrollees.

Lower federal deficits can also boost private investment, as CBO estimated that every dollar of federal borrowing “crowds out” about 33 cents of private investment – meaning firms invest less in areas that can boost productivity and workers’ wages.

CRFB noted CBO’s 2025 findings that stabilizing the debt as a share of GDP would boost real per-person income growth by one-tenth over the next three decades compared to their baseline and over 44% compared to a higher government debt scenario.

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Reducing budget deficits reduces the risk of a fiscal crisis and gives the government more flexibility during recessions, CRFB noted. (Elizabeth Frantz/File Photo/File Photo/Reuters)

That would amount to income per person growing by $46,500 with debt stabilized, or $32,350 if the debt is rising rapidly – an increase of about $14,250 individually and nearly $36,000 per household if the debt is stabilized.

Cost reductions and new tax revenues to shore up the solvency of Social Security and Medicare would also help prevent an affordability crisis from hitting seniors, who would face immediate benefit cuts if the trust funds that help finance those programs are depleted in the next decade as they’re currently projected to.

Social Security is facing an estimated 22% shortfall in 2032 when its trust fund reaches its projected depletion, which would trigger an automatic 22% cut for beneficiaries – roughly $500 per month in current monthly benefits.

CRFB added that deficit reduction could help the U.S. better prepare itself for future recessions, which can cause affordability challenges due to higher unemployment and slower income growth as well as higher government spending on relief programs. It can also stave off a future fiscal crisis caused by excessive growth in the national debt.

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“Responsible deficit reduction is not just an abstract concern for fiscal policymakers focused on bringing spending and revenue in line; it is one of the most powerful levers policymakers have to make daily life more affordable for American families,” CRFB said.