As the U.S. national debt surpasses $38 trillion and the debt-to-GDP ratio climbs to 120%, former Federal Reserve Chair Janet Yellen is sounding an alarm that few in Washington seem willing to hear. Speaking at the American Economic Association's annual meetings earlier this month, Yellen warned that America may be approaching a dangerous threshold that economists have long feared but rarely witnessed in advanced economies.

The concept is called "fiscal dominance"—a scenario where government debt becomes so massive that the Federal Reserve loses its ability to conduct independent monetary policy. Instead of fighting inflation, the central bank becomes subordinate to the Treasury's need to finance ever-growing deficits at manageable interest rates.

What Is Fiscal Dominance?

In a fiscally dominant environment, the central bank faces an impossible choice. Raising interest rates to combat inflation would dramatically increase the government's borrowing costs, potentially triggering a debt spiral. Keeping rates low to manage the debt burden would allow inflation to run unchecked.

"The preconditions for fiscal dominance are clearly strengthening. I worry we might be getting to the point where the car is too heavy for the brakes to work."

— Janet Yellen, speaking at the American Economic Association

Yellen, now a distinguished fellow at the Brookings Institution's Hutchins Center on Fiscal and Monetary Policy, pointed to Congressional Budget Office projections showing debt could climb to $50 trillion and reach 118% of GDP over the next decade—and potentially 150% over the next three decades.

The Bond Market's Growing Power

Heather Long, chief economist at Navy Federal Credit Union, reinforced Yellen's concerns with a warning about market dynamics. "The bond market is the new king in the United States," Long said at the same panel, explaining that for most nations, crossing the 120% debt-to-GDP threshold is a "game-changer" that gives bond investors significant influence over economic policy.

This dynamic was visible in the bond market turbulence of late 2025, when 10-year Treasury yields briefly spiked above 5% as investors demanded higher compensation for the risk of holding U.S. debt. While yields have since stabilized, the episode illustrated how quickly market sentiment can shift.

The Political Impasse

What makes fiscal dominance particularly insidious is its political dimension. Neither party has demonstrated sustained willingness to address the structural drivers of debt growth: entitlement spending, defense expenditures, and tax policy.

President Trump's "One Big Beautiful Bill Act," signed in July 2025, added significantly to projected deficits through tax cuts and expanded credits. While supporters argue the stimulus will boost growth and eventually pay for itself, independent analyses from the CBO and others project the legislation will add trillions to the debt over the coming decade.

Key Drivers of Debt Growth

  • Interest payments: Net interest on the debt is projected to exceed $1 trillion annually by 2027, making it one of the largest line items in the federal budget.
  • Social Security and Medicare: Demographic pressures from an aging population continue to strain these programs, with trust fund depletion projected within the next decade.
  • Defense spending: President Trump's proposed $1.5 trillion defense budget for 2027 would significantly exceed current levels.
  • Tax revenue shortfalls: Recent tax cuts have reduced projected revenue without corresponding spending reductions.

International Comparisons

The U.S. is not alone in facing elevated debt levels. Japan's debt-to-GDP ratio exceeds 250%, yet it has avoided the worst consequences of fiscal dominance—partly because most of its debt is held domestically and in its own currency. The U.S. enjoys similar advantages as the issuer of the world's reserve currency, but those advantages are not unlimited.

Countries like Greece and Argentina that lost market confidence faced severe economic contractions and were forced into painful austerity. While the U.S. is unlikely to face such an acute crisis, a gradual erosion of fiscal flexibility could constrain policy options during future recessions or emergencies.

What Can Be Done?

Yellen expressed cautious optimism that bipartisan cooperation could eventually address the fiscal trajectory. "I doubt that Americans will end up on the fiscal dominance course, but I definitely think the dangers are real," she said.

Potential solutions include:

  • Entitlement reform that extends the solvency of Social Security and Medicare
  • Tax reform that broadens the base while maintaining competitiveness
  • Discretionary spending caps with meaningful enforcement mechanisms
  • Economic growth initiatives that expand the tax base without increasing rates

For investors, Yellen's warning underscores the importance of monitoring fiscal developments alongside traditional economic indicators. A bond market that loses confidence in U.S. fiscal sustainability could trigger volatility across all asset classes—and limit the Federal Reserve's ability to respond.