With probably minor exceptions in Japan and in some E.U. countries, the entire burden of the G7 macroeconomic stabilization will fall on monetary policies.

Traditionally, that is the preferred modus operandi because politicians find their way out by blaming inflations and declining economic growth on nominally independent central banks. The general public, and, sadly, a fair amount of the economics profession, don’t see the linkage between monetary and fiscal policies.

Here is an example. The newly elected President Bill Clinton -- who ran, and won, in 1992 on the slogan “it’s the economy, stupid!” -- asked Alan Greenspan, the then Chairman of the Federal Reserve, how he could bring the bond yields down to get the economy growing. Greenspan told him that he could deliver falling bond yields if Clinton would give him declining budget deficits.

Clinton, the Democrat, did not believe Greenspan, a die-hard Republican, because a seminar he held a few weeks earlier with Nobel prize winning economists in Little Rock, Arkansas told him that there was an urgent need for billions of dollars in public works – i.e., government spending and rising budget deficits – to stimulate economic activity.

It took Clinton’s close friend, Robert E. Rubin, a former Wall Street bond trader -- who became the U.S. Secretary of the Treasury with a Senate vote of 99-0 -- to explain that Greenspan was right. Clinton then allowed Rubin to come up, and get approved, the 1993 Deficit Reduction Act.

U.S. will avoid default but not a recession

Over the next six years of Rubin’s tenure, a record-high $290 billion budget deficit turned into a $70 billion surplus.

And during that time, the U.S. economy grew at an average annual rate of 3.7%, inflation stabilized at 2.5% and the jobless rate declined to the newly coined concept of the “full employment unemployment rate” of 4.3%.

That is a timely reminder of a great American fiscal success story. Its message is a stark contrast to the U.S. Treasury’s warning that Uncle Sam could become a deadbeat next week if there is no agreement for another increase in the government’s spending authority.

Looking beyond the usual partisan debates, one should understand that such an authority is demanded by the Democrats who are running a budget deficit of 4% of GDP, a national debt of 121% of GDP and a core inflation of 5.5%.

The writing is on the wall. The spending authority will be granted, but the core inflation of 5.5% and unit labor costs rising 6% will inevitably lead to further interest rate increases in order to balance out demand and supply in labor and product markets.

People expecting that the “Fed is done” with interest rate hikes are talking about politics rather than sound monetary policies. Indeed, the policy interest rate (the federal funds rate) would have to be raised by another 2 percentage points to bring it to an inflation-adjusted level of 2%. But that would only be a neutral policy position. Higher interest rates are needed to stop and reverse the ongoing and generalized inflation pressures.

How far, and how fast, the Fed will go to bring inflation down from 5.5% to 2% is part of the political process leading up to general elections in November 2024. And if history of American politics is any guide, the Fed is quite unlikely to create a recession during an election period -- even if all efforts to manipulate inflation were to fail.

E.U. and Japan should think again

The E.U. politics play a much smaller role in monetary policy decisions of a supranational institution like the European Central Bank (ECB). Still, to Germany’s great regret, the ECB cannot allow a bankruptcy of member countries with unsound public finances. So, after a year of prevarication about a “temporary and reversible” euro area inflation, the ECB began a half-hearted credit tightening that brought its policy rate from 0% to 3.75%.

That, of course, was just a pinprick as shown by a new inflation upturn during April. The euro area core inflation (CPI less energy and unprocessed food) now stands at 7.3%, with inflation rates in Germany, France and Italy ranging from 7% to 8.7%.

The ECB is facing a tough call. The euro area economy has stagnated since the middle of last year. Germany is in a recession and France is in the same danger zone.

Interest rates, however, will have to go up. German bond yields are rising again in response to high inflation, and deeply indebted France and Italy are increasing public spending.

Japan, with a public debt of 251% of GDP, is also raising government spending to subsidize households’ declining purchasing power as a result of increasing food and energy prices. With hugely expansionary monetary and fiscal policies, Tokyo is trying to offset collapsing net exports. In the first quarter of this year, Japan’s GDP rose 1.3% on a 1.8% increase in domestic demand and a 0.5% decline of net exports.

Ignoring this worrying picture of their economies, the G7 leaders, meeting in Hiroshima, Japan, last week, had nothing to say about the fracturing global business cycle, with trade and financial flows moving along the lines of hostile geostrategic blocs.

That may not be an immediate problem for the large U.S. economy richly endowed with food, energy and technological resources. But the outlook for the E.U. and Japan is quite different. They are cutting themselves off crucially important food and energy supplies. And they are also losing business in their large and growing export markets.