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Team Ignite Insights · Sep 25, 2026 · 14 min read

Want to Slash Inflation? Slash Spending.

Core inflation is 2.4 percent, the lowest since 2021, yet the Fed just raised rates anyway because a war has cut off a fifth of the world's oil.

Read the Federal Reserve's own September 16 statement and try to find the emergency in it. Economic activity is expanding at a solid pace. Productivity growth is strong and capital investment is robust. Job gains have kept pace with the workforce, and the unemployment rate has changed little. Then, in the same short paragraph: twelve votes to zero to raise the federal funds rate a quarter point, to a range of 3.75 to 4 percent, the first hike since 2023.

Nothing in that description reads like an economy that needs cooling. So what were they responding to?

The August CPI report. Headline consumer prices rose 3.4 percent over twelve months. Core prices, which strip out food and energy, rose 2.4 percent, the lowest reading since March 2021. The gap between those two numbers is the whole story. Gasoline was up 27.4 percent from a year earlier and fuel oil up 52 percent, while shelter inflation eased to 3 percent and food to 2.7 percent, according to Trading Economics' breakdown of the BLS data.

The Fed raised the cost of every mortgage, car loan and credit card in the country because of gasoline. A rate hike cannot produce a barrel of oil. Tanker traffic through the Strait of Hormuz has collapsed roughly 95 percent, from more than a hundred ships a day to somewhere between five and twelve, with Brent crude near $105 a barrel in mid-September, according to one widely cited market analysis. You can raise rates until the housing market stops breathing and the strait will still be closed.

The numbers underneath this argument

  • Federal funds rate: 3.75% to 4.00%, +25 bps on Sept 16, 2026 (Federal Reserve)
  • Headline CPI, Aug 2026 (YoY): 3.4% (BLS)
  • Core CPI, Aug 2026 (YoY): 2.4%, lowest since March 2021 (BLS)
  • Gasoline, Aug 2026 (YoY): +27.4% (Trading Economics)
  • 30-year fixed mortgage: 7.19% (CNBC, Sept 16, 2026)
  • 10-year Treasury yield: ~4.97%, mid-September 2026 (Kiplinger)
  • FY2026 federal deficit: $1.9T, 5.8% of GDP (CBO, Feb 2026)
  • Debt held by the public: 99% of GDP (2025) rising to 120% (2036, projected) (CBO)
  • Net interest on the debt: $1.0T (2026) rising to $2.1T (2036, projected) (CBO)
  • Iran war, direct cost: $38B through Aug 1; $43.6B obligated by Sept 3 (CBO / CENTCOM)
  • War supplemental unrelated to the war: ~37% of the $87.6B request (CBO, via Roll Call)

The Fed is not being foolish here. When a supply shock runs long enough, people start expecting higher prices, and expectations become the thing that makes inflation permanent. Hiking is a signal, and it is the only lever the Fed owns. The deeper point is that it is also the only lever anybody in Washington seems willing to pull, and there is a second one sitting untouched.

The equation nobody says out loud

Start with the piece of arithmetic that sits underneath all of monetary economics.

Government debt is a promise. The real value of the government's outstanding debt has to equal the present value of every future dollar it collects above what it spends. If the government issues a large pile of new debt and people do not believe future budgets will ever cover it, the equation still has to balance. The only term left free is the price level. Prices rise, the dollars everyone holds buy less, and the real burden of the debt shrinks. Inflation becomes a quiet, partial default, paid by everyone holding cash.

Thomas Sargent and Neil Wallace made the sharpest version of this argument in 1981, in a paper called "Some Unpleasant Monetarist Arithmetic." Their claim was that a central bank facing a deficit it cannot control gets to choose when the inflation happens, and nothing else. Tighten today and the bill arrives tomorrow, at higher debt service, which makes the underlying problem worse.

Here is the correction most casual versions of this argument skip. The theory does not say deficits cause inflation. It says deficits cause inflation when people expect them to be unfunded, meaning not covered by future spending cuts, tax increases, or lower real interest rates, a distinction economist Luis Garicano drew out clearly in his comments on the leading empirical test of the idea. Borrowing that people believe will be repaid is just borrowing. Borrowing they believe will never be repaid is a tax on money.

That distinction explains Japan, which ran deficits for three decades with debt above 200 percent of output and got deflation, because nobody ever doubted Japan would pay. It also explains why a credible, legislated, multi-year plan to cut spending can lower inflation before a single dollar is actually reduced. The belief is the mechanism.

Where the evidence supports it

Hyperinflations end when budgets close. Sargent's 1982 study, "The Ends of Four Big Inflations," examined Austria, Hungary, Poland and Germany after the First World War. Each hyperinflation stopped abruptly, not gradually, and stopped at the moment the fiscal regime changed to a credible commitment to lower deficits. Money growth slowed after the change, not before it.

Argentina is the live experiment. Monthly inflation was 25.5 percent in December 2023, the month Javier Milei took office. By July 2026 it had fallen to 2.1 percent, with prices up 33.8 percent over the year, and June came in at 1.9 percent, the best reading in five years, according to reporting drawing on Argentina's national statistics agency. Economy Minister Luis Caputo forced the change through deep spending cuts and a budget surplus, with no money printed to cover the gap. He eliminated a deficit of roughly 5 percent of output within his first year, and Argentina posted a primary surplus of 1.4 percent of GDP in 2025, its first financial surplus since 2008.

The 2020 to 2022 inflation was substantially fiscal in origin. Robert Barro and Francesco Bianchi tested this across 37 OECD countries. Their measure of government spending had real explanatory power for inflation across 20 non-euro countries and the euro area as a whole, implying that 40 to 50 percent of the effective financing of that spending surge came from unexpected inflation eroding the real value of public debt, with the remaining 50 to 60 percent coming from conventional taxes and future spending cuts. Roughly half the pandemic was paid for out of everyone's checking account without a vote.

For the United States specifically, San Francisco Fed economists estimated that pandemic fiscal support may have raised American inflation by about 3 percentage points by the end of 2021, explaining why the United States diverged from other rich countries during that period.

Where it doesn't

The range of estimates should make anybody cautious about stating this too confidently. A 2025 Federal Reserve Board review of the literature notes that while one study puts the fiscal contribution to 2021 inflation at 3 percentage points, another respected estimate puts it at 0.3 percentage point. That is a tenfold disagreement among serious economists looking at the same period. Anyone who states the number with certainty is overselling it.

And the strongest objection to the whole argument, as applied to this specific moment, is the one that opened this piece. Core inflation is 2.4 percent. There is no excess demand left to squeeze out of the economy. American deficits sat near 6 percent of output from 2023 through 2026 while inflation fell from 9 percent to the low twos. If deficits mechanically produced inflation, that fall could not have happened.

Cutting spending today does not fix the gasoline number. That has to be said plainly before making this case anywhere, because the first economist in the room will say it.

What 1937 actually teaches

The FDR precedent gets invoked constantly by people who have not looked closely at it.

In the 1937-38 contraction, real output fell 10 percent, industrial production fell 32 percent, and unemployment climbed from 14.3 percent in May 1937 to 19 percent by June 1938, making it the third-worst recession of the twentieth century. The standard telling blames a balanced budget. What actually happened was several tightenings landing at once. The Fed doubled bank reserve requirements between 1936 and 1937. The Treasury sterilized gold inflows, preventing them from expanding the money supply. The Social Security payroll tax debuted in 1937, stacked on top of the tax increases already passed in the Revenue Act of 1935.

Economist Douglas Irwin's reexamination of the episode argues something more specific and more useful than the standard story. The severity of the downturn was not primarily caused by the fiscal contraction or by the higher reserve requirements, which were too modest on their own to produce a collapse that violent. Gold sterilization was the dominant force, because it did not merely slow the growth of the monetary base, it stopped it entirely.

Worth noting: inflation in 1937 was running around 3.6 percent, based on the era's CPI figures. Nobody was fighting a price spiral. Policymakers tightened fiscal policy, monetary policy and bank reserve rules simultaneously, into an economy still carrying double-digit unemployment. That is not a template for anything except what to avoid.

The better guide comes from Alberto Alesina, Carlo Favero and Francesco Giavazzi, who studied fiscal consolidation plans across 16 OECD countries over roughly three decades. Their finding: consolidations built on spending cuts produced much smaller output losses than consolidations built on tax increases, often mild and short-lived recessions or none at all, while tax-based adjustments were followed by prolonged, deep downturns. The difference held even after controlling for monetary policy; it traced mainly to how business confidence and private investment reacted. Announced in advance, legislated, spread over years, weighted toward spending rather than taxes. Slow is the design, not a compromise forced on it.

The channel that skips inflation entirely

There is a stronger version of this argument, and it does not need the inflation mechanism at all.

Deficits raise long-term interest rates directly, through what economists call the term premium, the extra yield lenders demand for holding long-dated debt. Thomas Laubach's benchmark study found that a one percentage point increase in the projected deficit as a share of output adds roughly 25 basis points to long-horizon forward rates, and 3 to 4 basis points for each point of projected debt. That result has held up under scrutiny. A 2025 study rerunning the analysis on a fifty-year sample found that a 1 percent of output increase in the deficit is associated with roughly 20 to 30 basis points on long-term rates, with the relationship growing stronger as fiscal positions worsened. A 2025 Dallas Fed replication put the figure at 16.8 basis points on the five-year-five-year forward rate.

Run the arithmetic against the table above. CBO projects a $1.9 trillion deficit for fiscal 2026, 5.8 percent of output, with debt held by the public climbing from 99 to 120 percent of output by 2036 and net interest rising from $1.0 trillion to $2.1 trillion over that period. A credible plan that cut the deficit by two points of output would, on these estimates, take something like 40 to 60 basis points off long Treasury yields. Mortgages price off the 10-year Treasury.

Look at where those two numbers sat as the Fed met: the 10-year yield near 4.97 percent, and the 30-year fixed mortgage at 7.19 percent, according to CNBC's coverage of the September rate decision. The Fed controls the short end. It sits at 4 percent. Most of the 320 basis points between that and the mortgage rate is not set by the Fed, and a meaningful slice of that gap is the market pricing the fiscal trajectory.

Which means the two tools work differently in a way nobody says out loud at the podium. A rate hike lowers inflation by breaking demand, which means costing somebody a job. Cutting the deficit lowers long rates partly by removing a risk premium, which costs nobody a job. Those are not interchangeable instruments, and the less painful one is the one Congress refuses to touch.

What would actually have to be cut

Making this case honestly means naming what gets cut, and the honest answer is unpleasant. Of the 5.8 percent deficit, the primary deficit (spending minus revenue, excluding interest) is 2.6 percent of output and net interest is 3.3 percent. Interest is not negotiable once the debt exists. CBO projects outlays climbing toward 24.4 percent of output by 2036, driven by Social Security, Medicare and interest. The structural deficit is retirement programs, health programs, defense and the compounding cost of past borrowing. Eliminate every line item people mean when they say "waste," and the deficit is still there.

Which makes the last several months instructive. While the Fed was raising rates to fight inflation, the White House had an $87.6 billion supplemental spending request in front of Congress, $67.1 billion of it for the Pentagon. Of that defense request, CBO judged $42.3 billion directly related to the Iran conflict, meaning close to 37 percent of the total package was not tied to the war it was ostensibly funding. CSIS's own breakdown put roughly a third of the request as war-driven, with the rest funding other administration priorities. CBO separately estimated the war's direct cost at $38 billion through August 1, running $2 to $3 billion more per month, and by mid-September CENTCOM told Congress it had obligated $43.6 billion, split roughly between munitions replacement, operations, and equipment losses. That sits alongside a record $1.5 trillion defense budget request submitted in April.

In the middle of an inflation serious enough to reverse three years of Fed policy, more than a third of a war supplemental was not about the war.

Two questions worth asking

Any representative willing to talk about inflation should be able to answer two questions, neither of which is rhetorical.

Name the three programs you would cut to reduce the primary deficit by one percentage point of output, and give a date for the bill. Not a commission. Not a framework. A bill, with numbers attached.

Then explain the 37 percent.

A speech about corporate greed, or about the other party, answers neither question. It is the sound of someone who has never priced out what they claim to believe.

None of this brings gasoline back to three dollars. A gallon reached roughly $4.15 nationally in early September, with Brent up sharply over the prior month, because tankers are not moving through a twenty-two-mile channel. Congress cannot legislate that away and should not be blamed for the war itself.

What Congress chose, over twenty-five years and both parties, was to enter this energy shock carrying debt near 100 percent of output and a trillion-dollar annual interest bill. That part has names attached to it, and it shows up in a place where there is nothing else to blame it on. Iran explains the price at the pump. Iran does not explain why the Fed's rate sits at 4 percent while the mortgage quote sits at 7.19.

That spread is the deficit. It arrives in the mailbox every month, it has no war behind it, and nobody has to vote for it because it already passed.

Sources

Current data

War supplemental

Fiscal theory of the price level

Argentina

1937-38 and consolidation design

Deficits and long-term rates

This article is for general informational purposes only and does not constitute investment, legal, tax, or accounting advice, nor an offer or solicitation to buy or sell any security or investment product. Investing involves substantial risk, including possible loss of principal, and past performance is not indicative of future results. Full disclaimer.

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