The recent rise in long-term US Treasury yields has revived a familiar story about fiscal irresponsibility. Commentators point to large federal deficits, growing public debt, and the volume of Treasury securities coming onto the market. From this perspective, higher yields are the market’s response to excessive government borrowing, and the Trump administration’s policy amounts to fiscal recklessness. This interpretation rests on an old and misleading conception of financial markets. It treats government and private borrowers as competing for a limited pool of savings, so that larger deficits necessarily drive interest rates upward. But interest rates in a modern monetary economy are not determined in this way. The Federal Reserve (Fed) directly sets the short-term policy rate and strongly influences the entire yield curve through changes in the composition and size of its balance sheet and through expectations about future rates.

The current rise in long-term rates is better understood from this monetary perspective. Inflation remains above the Fed’s 2 percent target, and the energy shock associated with the Iran war has reinforced fears that inflation will persist. These fears are exaggerated. Inflation above 2 percent is not, by itself, evidence of an inflationary crisis, particularly when there is no distributive conflict capable of generating a self-sustaining wage-price spiral. The deeper problem is the Fed’s commitment to an excessively low inflation target. Because policymakers treat even moderate inflation as requiring restrictive policy, short-term rates remain unnecessarily high, and expectations of higher rates feed through to longer maturities.

Long-term yields must also be understood against the extraordinary monetary policies adopted after the global financial crisis. Quantitative easing deliberately reduced long rates by having the Fed purchase large quantities of Treasury securities. As the Fed bought long-term Treasuries, its price went up, and its yield, the long-term interest rate, went down. The subsequent retreat from those policies removed an important source of downward pressure on yields. However, the 10-year Treasury yield that appears high relative to the exceptional post-2008 period remains modest by longer historical standards. Nothing about current yields demonstrates that US public debt has become financially unsustainable. Indeed, the experience since 2008 shows that when the Federal Reserve wants to affect longer-term Treasury rates, it has the means to do so.