It is impossible to minimize the size of the economic problem that faces us. The next secretary of the Treasury will face difficulties that would have challenged even Alexander Hamilton. The problems include the enormous unfunded promises to pay for health care and medicines for an aging population while restoring economic growth. Add to that the Fed’s eventual need to raise interest rates to slow money and credit growth and prevent inflation—which could thwart growth and generate a federal deficit surge. Then there is the imperative of reining in costly regulations.

Neither candidate in this year’s presidential election campaign warned about the problems the country faces in getting on a path to relatively stable growth at or near the historic average, with manageable inflation. While both were probably aware of the problems, neither was willing to mention them. Many candidates for the Senate and the House campaigned on the need for greater budget discipline and less regulation, but few offered specific proposals.

In the last four years, the U.S. Treasury borrowed $55,000 per household to finance its budget deficit of more than $1 trillion a year. On top of that, the country now faces the immediate problem of the “fiscal cliff”. These are difficult, but they are not the most difficult.

More difficult decisions include: What amount of U.S. military spending is needed to support our alliances around the world and encourage adversaries to remain peaceful? Stresses in Asia and the Middle East will not disappear. Advocates of defense will caution that near-term military weakness will encourage adversaries and require much greater spending in the future. Opponents will point out that U.S. defense spending is much larger than spending by any other country or group of countries. What new tax or spending programs will raise productivity and employment? How much should we invest in skill training and retraining? Can we increase growth and jobs while moving toward a balanced budget? Can we find ways to increase learning and retention?

The Federal Reserve has kept short-term interest rates near zero and has promised to continue doing so for two or more years. Long-term interest rates are an average of expected short-term rates, so promising to keep short-term rates near zero contributes to the lowest long-term rates in our history. That policy raises havoc with the investment return on which retirees depend and on pensions for workers in public and private pension plans. And it is a severe burden for the retired who live on the returns earned on their investment. Many are taking much bigger risks, a decision that often leads to tears and regrets. Others reduce their spending and draw down their assets, reducing their nest eggs.

About $10 trillion of the debt is held by the public. About 30 percent has less than one year to maturity. An additional 40 percent has one to five years to maturity. I estimate that a three-percentage-point increase in interest rates would increase government spending and the budget deficit by $100 billion when the government refunds the debt under one year. About 45 percent of the debt is held abroad, mostly in longer maturities. After allowing for foreign investors to hold a smaller percentage of short-term debt our payments to foreign holders increase by about $30 billion in the first year and substantially more in later years as a larger percentage of foreign debt is refunded.

These calculations understate the problem because they exclude government agency debt and private debt held abroad. And they exclude the costs that the government mortgage agencies and the Federal Reserve will have to pay when they refund their debt. When interest rates rise, debt values fall so there will be large losses in the value of outstanding debt. Our government has difficulty agreeing on budget reductions and mostly ignores the current account deficit. But large increases for interest payments cannot be ignored.

The enormous unfunded promises to provide health care and medicine to seniors through Medicare and to low- and middle-income groups through Medicaid approach $100 trillion. Both political parties made the promises. Some, including President Obama, argue that we can reduce the problem substantially by raising tax rates paid on incomes above $250,000. But the top 1 percent now pay 37 percent of the income tax, while the bottom 50 percent pay almost nothing. Many of these people receive payments from the Treasury under a program designed to reward work.

Many countries have tried to increase tax revenue by expanding taxes on the highest incomes. Much of that income comes from capital gains. The general experience is that not much revenue is raised because capital gains are realized before the new tax rates become effective. When rates move up, owners of capital take fewer gains. Not only do investors greatly reduce the capital gains they take, some move to countries with lower taxes rates. Sweden repealed the higher tax it enacted a few years ago because it raised little revenue.

Some increases in tax revenues will be realized, but most deficit reduction must come from lower current and especially future spending. The challenge is to find humane ways to reduce spending. This is both desirable and possible. Our health care system is very inefficient. Many repeat that we spend more per capita and in the aggregate than other countries but do not have the best results. One reason is that we spend at least 50 percent of total health spending on people in the last six months of life. They receive expensive care that other countries do not offer. Instead of providing costly care without charge, we could require a co-payment graduated according to income. Doctors would counsel patients on the treatments, the likely benefit, and the costs to them. Many would choose hospice care and avoid treatment.

There are many other reforms that would increase efficiency and lower cost. Greater reliance on nurse-practitioners instead of doctors and ending the payment system that rewards procedures instead of patient care are other examples. Giving states control of Medicaid would lower cost.

A huge problem faced by the country is the growing power of the Federal Reserve, which began almost a hundred years ago as a public-private partnership with limited powers. Today, its power to expand money and credit is unlimited in practice. In a republic such as ours, no one and no agency should have such unrestricted power to expand. Congress must restrict Federal Reserve actions through legislation.

Throughout its history, the Federal Reserve has achieved low inflation and relatively stable growth, punctuated by small recessions, in only two periods. One was the gold exchange standard from 1923 to 1928. The other was 1985-2003, when the Federal Reserve approximately followed what was known as the Taylor rule. Named for economist John B. Taylor, it was designed to calibrate appropriate interest rates based on inflation and other factors. There are no comparable periods under discretionary policy. The only candidate is the 1950s, but the decade from 1953 to 1962 had three recessions, including a rather sizable, short recession in 1957-1958.

No rule will work perfectly, so policy must give the Federal Reserve some flexibility. If they miss the inflation or growth targets specified by the rule, Fed governors must offer an explanation—and their resignation. The political authorities can accept the explanation or the resignations. Several countries with announced inflation targets have adopted a rule of this kind.

In the past, Federal Reserve officials have made major mistakes. The Great Depression of the 1930s and the Great Inflation of the 1970s are well known. Failure to recognize the difference between monetary and non-monetary problems contributed to both errors, and to others as well. The current Fed is repeating that error. The slow recovery is mainly a result of heightened uncertainty about taxes, healthcare, energy and other costs. It is not the result of insufficient money or liquidity. Adding more liquidity in QE3 will not help. Banks are awash in idle reserves—currently more than $1.5 trillion compared to $100 billion or less before the recent crisis. Corporations hold hundreds of billions of cash. Adding more reserves simply complicates the huge problem of reducing reserves when inflation starts to rise. That’s a big problem that current policy is making bigger.

My friends at the Fed tell me not to worry. All they have to do, they say, is raise interest rates. Not so easy in practice. Remember that higher interest rates will have to be paid by government (on the debt as it rolls over) and by private borrowers as well. Much of the debt has a short term to maturity, so the increase in interest payments comes upon us quickly. As the debt comes due, Congress will face hundreds of billions of additional interest payments. Even if Congress and the president finally agree on deficit reduction, they will be hit with increased spending to service the debt. Inflation makes the problem worse—much worse—because interest rates will increase as they did in the 1970s and early 1980s.

The Fed also faces an enormous balance-sheet explosion. I do not believe they have a coherent, workable plan to withdraw the excess reserves they have created. Congress should insist on seeing a detailed plan.