Please see below the daily update article from WH Ireland, received this morning – 18/09/2026
The Federal Reserve has started raising interest rates again. Inflation remains too high and domestic spending resilient. But there is something unusual about this tightening cycle. Fiscal and monetary policy are pulling in opposite directions.
Washington is running a budget deficit approaching 6 per cent of GDP, despite an economy close to full employment. The Trump administration’s tax and spending changes are expected by the IMF to add about 0.75 per cent to GDP in 2026-27 while increasing the deficit.
Fiscal policy is supporting demand just as the Fed is trying to restrain it. The government is pressing the accelerator while the central bank presses the brake.
That makes a 45-year-old piece of economics suddenly relevant. In 1981, Thomas Sargent and Neil Wallace published Some Unpleasant Monetarist Arithmetic. Their conclusion was uncomfortable: under the wrong fiscal conditions, tighter monetary policy today can create problems for monetary policy tomorrow.
The arithmetic is straightforward. When a government spends more than it collects in taxes, it borrows the difference by selling bonds.
But bonds carry interest. Governments feel higher rates more slowly than households because existing debt does not reprice overnight. Instead, cheap bonds mature and are replaced by more expensive ones. Unless taxes increase or spending falls, the government must borrow more to meet the rising interest bill.
This creates a peculiar circle. Fiscal policy supports demand, contributing to the conditions requiring tighter monetary policy. Higher rates then increase government borrowing costs, adding to future deficits and debt.
The numbers are uncomfortable. The Congressional Budget Office projects federal debt held by the public rising from about 101 per cent of GDP this year to 175 per cent by 2056, against just 35 per cent before the financial crisis. Net interest costs rise from 3.3 per cent to 6.9 per cent of GDP. The debt is not only larger; it is becoming more expensive to carry.
The Fed can raise rates to fight inflation, but it cannot fix the budget deficit. If fiscal policy continues to support demand, the Fed may instead have to raise rates further to offset it — exactly the opposite of the lower rates the Trump administration is calling for.
That makes the circle still more unpleasant. Larger deficits can require higher interest rates; higher rates increase the government’s interest bill; and a larger interest bill adds to the deficit.
Sargent and Wallace argued that this cannot continue indefinitely. There is ultimately a limit to the government debt private investors will absorb. Once that limit is reached, something has to give.
In their model, the government refuses to cut spending, raise taxes or default. Eventually the central bank has to create money to finance obligations that can no longer be funded with more debt.
That does not mean higher rates are ineffective. They can reduce demand and inflation today. Sargent and Wallace’s warning comes later. If fiscal policy still does not adjust, eventually the combination of loose fiscal policy and tight monetary policy cannot be sustained.
America has other choices. Taxes can rise, spending can fall, or regulation can encourage domestic institutions to hold more government debt. Inflation itself can reduce the real value of nominal liabilities.
But the central insight survives. The Fed can determine interest rates. It cannot determine how much Washington borrows. If fiscal policy does not adjust, it can eventually dictate what monetary policy is able to do.
For decades, developed-market government bonds have been treated as the “risk-free” assets against which everything else is priced. Sargent and Wallace turn that relationship around.
For investors, the question is no longer simply where interest rates are going.
It is whose balance sheet they want to lend to.
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Cherise Lancaster
18th September 2026