Institutional Risk Analyst editor R. Christopher Whalen has written an insightful article exploring the origins of the new liquidity crisis the Federal Reserve is now fighting, a crisis in which the U.S. government’s fiscal policies—how it imposes taxes and spends money—may have played a major contributing role.

Whalen provides a good primer for understanding a situation that one analyst has described as a potential “Black Swan event,” a catastrophic occurrence that is generally believed to be so unlikely that when it shows up, nobody is prepared to cope with it because it was too unpredictable.

For today’s liquidity crisis, a Black Swan event may be touched off by the sudden flooding of the nation’s bond markets with newly issued Treasury bills and bonds to replenish the U.S. Treasury’s operating funds after an extended period of “extraordinary measures” to keep the U.S. national debt under its statutory limit and to finance new government spending authorized by the Bipartisan Budget Act of 2019.

Before the last two months, hardly anyone was considering whether the U.S. government’s operational financing requirements to sustain its fiscal policies could precipitate an emergency central bank intervention to keep markets functioning. In normal circumstances, the two kinds of policies are set independently of each other, such that monetary policy is irrelevant to fiscal policy and vice versa.

Following the sudden development of the new liquidity crisis, however, Whalen asked several market analysts the question, “Is fiscal policy ‘irrelevant’ to monetary policy?” He presents the responses he received, which range from “Yes. Yes. And yes it is” through “It is certainly not irrelevant.” Perhaps the most interesting response was from Robert Bruca, the chief economist at FAO Economics, who said:

No, fiscal policy is never irrelevant. But no one is trying to make them work together either. So it is easy to see how some might think fiscal policy is irrelevant. In the 1980s Volcker held up a rate cut telling Congress it had to pass a bill to contain the deficit before he would cut rates. Janet Yellen and her Fed went ahead with a program of rate hikes in part because it saw the Trump tax cuts and fiscal policy as too expansive at a time the economy had ‘few idle resources’. That did not turn out well as the Fed over tightened and is currently in the process of rescinding its excessive rate hikes. The main ‘problems’ with fiscal policy is that it is too tempting. Keynes’ Idea was to use it as a counter-cyclical tool- on then off. But once governments start using fiscal policy for economic expansion they just can’t control themselves – fiscal policy is the opiate of the elected.

In the 1930s, John Maynard Keynes argued that when the economy was in recession, the government could stimulate aggregate demand by running a budget deficit, thereby increasing government spending as even tax revenues fall. As the economy resumed growing, the government would then cut its spending to below the recovering tax revenues, with the aim of balancing the budget over the long term.

Keynesian policies were dropped with the implementation of the Great Society programs of the 1960s, and ever since then the government has continually run budget deficits with few exceptions. The Bipartisan Budget Act of 2019 and the spending it enabled is only making the situation worse.

Isn’t it time the politicians and bureaucrats who run the government reined in their opiate addiction and went into rehab?