Fiscal deficits of the magnitude projected are large enough to damage future growth prospects of the U.S. economy, which in turn magnifies our vulnerability to a decline in the willingness of other countries to lend us their savings, which could lead to higher risk premia on U.S. financial assets, also damaging long-term growth prospects...Building a stronger fiscal cushion and strengthening confidence in our fiscal sustainability is critical to reducing the risk in the size of our external imbalance

The economic impact of any given deficit almost certainly depends on the spending and tax policies that give rise to the budget shortfall...But it would not be shocking to find that there might be some interest-rate pressure from this source, at least in the short run.

The present fiscal trajectory entails an uncomfortable scale of borrowing and little insurance against possible adverse outcomes in an uncertain world.

Our country is going deeper into debt to pay for consumption instead of investment, and in my view this trend is undesirable and at some point unsustainable. If our current account deficit continues to grow, foreign investors can’t be counted on to keep lending to the United States on the same terms as in the past...These pressures are made even more worrisome because we are using part of the proceeds from borrowing abroad to finance our current account deficit while we are also using part to finance our growing domestic fiscal deficit—the other twin.

In 2005, our fiscal policymakers have an excellent chance to strengthen the nation’s economic foundations by demonstrating a renewed commitment to reducing the federal budget deficit. Also, we face the more daunting task to confront looming deficits for Social Security and even more costly medical programs.

I have outlined several risk factors that could alter the short-term dynamics of the economy - oil prices, the trade balance and the federal budget. The course that these factors take will figure into the precise path the Fed follows.

The imbalance in the federal budgetary situation, unless addressed soon, will pose serious longer-term fiscal difficulties...The longer we wait before addressing these imbalances, the more wrenching the fiscal adjustment ultimately will be.

Most long-term interest rates, however, have barely budged despite the appreciable reductions in short-term rates since the beginning of the year. This has led many commentators to ask whether inflation expectations have risen. Surely, one reason long-term rates have held up is changed expectations in the Treasury market, as forecasts of the unified budget surplus were revised down, indicating that the supplies of outstanding marketable Treasury debt are unlikely to shrink as rapidly as previously anticipated. Beyond that, it is difficult to judge whether long-term rates have held up because of firming inflation expectations or a belief that economic growth is likely to strengthen, spurring a rise in real long-term rates.