Quantitative easing and the Fed’s free lunch problem

By Steve Swedberg of CEI. Excerpt:

"QE operates primarily through asset price channels, which means that it compresses risk premia and increases market responsiveness to central bank communication. This can create artificially elevated asset prices, encourage greater risk-taking during periods of accommodation, and also increase financial system exposure.

Over time, this weakens the informational role of prices. Capital allocation becomes increasingly shaped by policy-driven conditions instead of market-based signals. That shift can reduce the efficiency of investment, thereby directing resources less consistently to their most productive uses.

Because productivity is the primary driver of long-run growth, wages, and economic resilience, even incremental distortions in capital allocation can weigh on the economy’s underlying performance over time. What begins as a stabilization tool can, if sustained, alter the structure of financial decision-making.

Setting the stage for the hard part

Against this backdrop, balance sheet reduction is a means of re-establishing clearer price discovery and restoring policy space for future downturns. It is a step toward rebalancing the role of the Federal Reserve’s balance sheet in monetary policy. QE has altered financial markets in ways that persist well beyond the crisis it was meant to address. Sustained intervention weakens the role of market signals and makes financial conditions more reliant on policy-driven forces. As these effects become embedded in market behavior, stepping back from QE becomes more difficult. The central challenge is whether the balance sheet can be reduced without severe consequences."

Fed’s Defense of IOR Undermined by Weak Treasury Auctions

By Jai Kedia of Cato.

"It is never a good sign when government debt auctions make the news, as was the case this week when the Treasury tried to sell $69 billion in two-year notes. Weak demand for these assets pushed their yield up to 3.9 percent. Ten-year and 30-year Treasury yields spiked, too, and all of this despite the Fed keeping its target rate unchanged at its latest meeting.

The proximate cause for the market’s suppressed bond appetite was rising inflation anxiety tied to Middle East tensions and oil prices. But this episode inadvertently illuminated something more fundamental: a hole in one of the Federal Reserve’s favorite defenses of its interest on reserves (IOR) program.

The Fed’s Substitution Argument

The Fed currently pays banks a risk-free administered rate on trillions of dollars in reserve balances through the IOR framework. When Congress or outside critics raise the cost of IOR, the Fed has a ready response. Its own FAQ webpage on the subject states that if a bank held Treasurys instead of reserves, “the bank would still earn interest paid by the government—both Treasury securities and reserves are government liabilities—and there would be no net effect on interest earned or paid by the government.”

In short, the Fed argues that IOR and Treasurys are fiscal equivalents. Remove IOR, and banks would simply shift into Treasurys. The government would pay interest either way, and taxpayers would be no better off. The substitution argument treats Treasury securities and reserve balances as interchangeable assets that banks would hold at identical yields. But that is not how markets work, nor is it how banks make investment decisions.

We have critiqued this argument and several others in the past, but Tuesday’s auction offers a real-time case study of why this substitution argument is wrong.

Markets Price Risk and Send Signals. IOR Does Not.

When the Treasury auctions securities, it does not set the yield. The market does. Investors, including banks, assess duration risk, inflation risk, liquidity needs, and opportunity costs, and then bid accordingly. If they think the offered yield is too low relative to those risks, they simply don’t bid, or they bid less aggressively. That is precisely what happened at this week’s auction. Inflation uncertainty made investors skeptical that the two-year note was fairly priced, and the auction showed it.

IOR operates entirely differently. The rate is set administratively by the Fed’s Board of Governors. Banks don’t bid; there is no market or auction for these funds. Correspondingly, there is no price discovery nor any mechanism by which banks can signal that the rate is suboptimal. Reserves are overnight liabilities of the Federal Reserve, not term obligations subject to duration or inflation uncertainty. They are, by design, the safest asset in the financial system guaranteed by the Fed’s ability to simply add numbers to banks’ accounts (as inadvisable as it may be to do so).

This is the flaw in the substitution argument. It assumes that if IOR were eliminated, banks would absorb trillions in Treasury securities at whatever yield prevailed, bidding rates down until Treasurys became equivalently attractive. But banks are optimizing investors. They demand compensation for risk. A two-year (or longer) note carries meaningful inflation and duration risk; an overnight reserve balance does not. These are not the same instrument, and rational investors do not price them identically. That price is a signal; while that signal may be costly to the Treasury, it is informative.

The Bottom Line

IOR imposes no market discipline. The rate is set by the same institution that controls monetary policy, paid to the same banks that are counterparties to Fed operations, and bears no relationship to market pricing. It is a transfer, administered by fiat, insulated from the price discovery that makes Treasury markets meaningful. Treating these two instruments as equivalents, as the Fed’s argument requires, ignores economic and institutional differences.

This week’s auction was just an example. It showed that investors care about the conflict in the Middle East. If they were to engage in further Treasury auctions with the money they currently park at the Fed to receive IOR, it might reveal a host of other important signals. For instance, we may discover (as markets demand higher yields) that people have a limited appetite for US debt if the federal government shows no signs of ending its fiscal profligacy. As it stands, the government can simply have the Fed monetize its unending debts under the cover of IOR.

This week’s auctions were, on the surface, a story about oil prices and Middle East risk premia. But it was also a reminder that investors don’t passively accept whatever yield the government puts in front of them. IOR is not a perfect substitute for Treasurys. Pretending they are the same is not a defense of sound monetary policy. It’s a rhetorical sleight of hand."

A Divided Fed Cuts Rates Again—but Why?

The central bank predicts faster economic growth in 2026 but still eases again

WSJ editorial. Excerpts:

"When the rate cuts began more than a year ago, officials predicted they’d get inflation back to the Fed’s 2% target by 2026. That deadline keeps getting pushed back, and in the Summary of Economic Projections released with Wednesday’s policy decisions, the 2% arrival date is now 2028."

"Mr. Powell says this isn’t quantitative easing to achieve lower interest rates or economic growth. They believe they need to expand their asset holdings to match the level of reserve deposits commercial banks are likely to want to hold. But it’s a reminder that the Fed’s post-2008 “ample reserves” policy framework probably will require the Fed to be a net purchaser of Treasurys forever. Remember when this extraordinary Fed intervention in financial markets was going to be temporary?"

The Fed’s MBS Problem: How QE Helped Inflate Housing Markets

By Norbert Michel and Jerome Famularo of Cato.

"On October 14, Fed Chair Jerome Powell delivered a speech about the Fed’s balance sheet, and to start, he joked that this topic is comparable “to a trip to the dentist, but that comparison may be unfair—to dentists.” As people who frequently write about this topic, we empathize.

Hardly anyone cared about the Fed’s balance sheet prior to the 2008 financial crisis, but the Fed’s decision (in December 2008) to start purchasing long-term Treasuries and agency mortgage-backed securities (MBS) changed all that. By 2014, the Fed had engaged in three separate rounds of these purchase programs, known as quantitative easing (QE), and it held more than five times the securities it had prior to 2008. While the Fed eventually began a slow runoff of these securities after 2014, it engaged in massive securities purchases during the COVID-19 pandemic, bloating the balance sheet far above the previous peak.

Agency MBS, the securities issued by Fannie Mae and Freddie Mac, have always been one of the more controversial components of these purchases. Rather than provide liquidity on an economy-wide basis, these MBS purchases helped allocate credit directly to housing markets. Moreover, they helped prop up the market for Fannie’s and Freddie Mac’s debt while the companies were in federal conservatorship. During the COVID-19 pandemic, these purchases opened the Fed to even more criticism because they occurred after eight years of increasing housing prices and coincided with mortgage rates declining to their lowest levels in decades.

In his speech, Chair Powell acknowledged recent research that suggests the Fed’s MBS purchases between 2020 and 2022 were related to increasing home prices. Powell also noted, correctly, that the Fed’s MBS purchases were not the only factor driving house price appreciation during the pandemic. There were likely other causes, such as the increase in demand stemming from the rise in remote work.

Still, some research, including a paper from the Kansas City Fed, suggests that these MBS purchases affected both borrowing rates and housing prices. Given the size of the Fed’s purchases, this relationship is not too surprising.

As Figure 1 shows, during its initial QE programs, agency MBS purchases resulted in the Fed taking a 21 percent share of the MBS market in 2010 and nearly a 30 percent share by 2014. Their share of the market fell prior to 2020 but soon increased to almost 30 percent. During these purchase programs, the Fed was the second largest investor in the MBS market—combined, the Fed and the banking sector held more than a 50 percent share of the MBS market.

 

Given such a large volume, it would be strange if the Fed’s MBS purchases had no effect on home prices or interest rates. Additionally, compared to purchasing Treasury securities, MBS purchases should have a more direct effect on mortgage rates and house prices because they artificially increase demand for mortgages.

This paper by the Kansas City Fed estimates that the Fed’s MBS purchases between 2020 and 2021 led to a 0.4 percent decrease in the difference between mortgage rates and Treasury yields, a difference known as the mortgage spread. During much of this period, mortgage rates were decreasing, and long-term Treasury yields were increasing. The paper reports that “banks and the Fed were each responsible for about a 40-bps reduction in the mortgage spread during 2020/21,” leading to “a cumulative increase in mortgage originations of about $3 trillion and net MBS issuance of about $1 trillion, with banks responsible for about half of this increase.”

When mortgage rates drop, more people can afford mortgages, which increases demand for houses. This surge in demand, all other things held constant, increases house prices until supply increases to meet the new demand. There is a range of estimates for the effect of mortgage rates on house prices, and recent estimates suggest that the effect has been increasing and was particularly strong during the pandemic.

What began as a temporary emergency response to a crisis has morphed into a primary feature of modern central banking. As a result, the Fed’s balance sheet has ballooned to historic proportions, from less than $1 trillion in 2007 to nearly $9 trillion at its peak in 2022, largely due to successive rounds of QE. Whether QE worked as intended is debatable, but it has undoubtedly expanded the Fed’s balance sheet and drawn the Fed into financial markets and fiscal policy beyond its traditional role.

In particular, the Fed’s MBS purchases have distorted the housing market, pushing prices higher and fueling calls for even more government intervention. To prevent direct credit allocation and to minimize the Fed’s footprint on financial markets, Congress should require the Fed to trade only short-term US Treasury securities. That process might be politically difficult, but it wouldn’t be as bad as going to the dentist."

Fed Independence Goes to Court

Trump loses his case to fire Lisa Cook, but it’s likely headed to the Supreme Court.

WSJ editorial. Excerpts:

"The Federal Reserve Act provides members of the Fed board with staggered 14-year terms and lets the President remove them only “for cause,” which isn’t defined by the law."

"“for cause” may have a broader sweep than wrongdoing in office. The High Court this spring also allowed Mr. Trump to fire a Democratic member of the NLRB notwithstanding removal protections (Trump v. Wilcox).

But the Court also noted in dicta that its ruling did not “necessarily implicate the constitutionality of for-cause removal protections” for the Fed, which “is a uniquely structured, quasi-private entity that follows in the distinct historical tradition.”"

"its [the Fed] control over monetary policy is unique.

Mr. Trump is challenging legal norms as he aggressively uses executive power. He’s won many cases, but this one is no easy call."

Trump, Lisa Cook and the Federal Reserve’s Independence

The central bank differs from other agencies in that the power to coin money belongs to Congress

By Phil Gramm and Jeb Hensarling. Excerpts:

"The Constitution gives Congress the power to coin money and regulate its value. Congress, in fulfilling that delegated responsibility, created the Federal Reserve. In carrying out narrowly defined monetary policy, the Fed isn’t subject to executive authority."

"Congress created a central bank with seven board members, or governors, appointed by the president and confirmed by the Senate."

"By involving itself in the political process, the Fed undercut the argument that it should be independent of that political process."

[Powell] "helped cause that inflation" 

"based on the argument that the inflation was the result of a supply shortfall and therefore transitory. That argument wasn’t credible given that the federal government was spending more in two years than it had ever spent in three and the Fed during the pandemic was expanding the money supply faster than in any other year since World War II ended."

"Her “for cause” firing appears to be another assault on monetary policy independence."

"in creating the Federal Reserve, Congress delegated an enumerated power that Article I, Section 8 of the Constitution had given it."

"the Founders concluded that the safest bet was for Congress to hold “the power to coin money and regulate its value thereof.”" 

"Congress . . . had no authority to delegate its enumerated power to the executive branch."

"the Fed is accountable to Congress in conducting monetary policy."

"But the Fed in conducting monetary policy isn’t an executive-branch agency. It is carrying out a function given by the Constitution to Congress."

"Presidential control of monetary policy would be a threat to financial stability and American prosperity." 

Powell Flips the Fed’s ‘Framework’

The central bank abandons its 2020 idea that inflation above its target can be useful.

WSJ editorial. Excerpts:

"The Fed at that time adopted what it called “flexible average inflation targeting.” That’s Fed-speak for saying the central bank would tolerate inflation higher than its 2% target for a time to compensate for inflation that was lower than 2% for a period."

"inflation hit 9.1% at its peak in June 2022."

"The Fed said sayonara to this on Friday, returning to plain old “flexible inflation targeting”—with the target being 2% inflation."

"failure of the Fed to acknowledge its role in igniting the pandemic-era inflation that we haven’t fully recovered from."

"One question is why the Fed has an inflation target at all. Congress has given the Fed the duty to maintain stable money, and a 2% target over time means a steady decline in the dollar’s purchasing power."

"Why not a target of zero inflation? The fear at the Fed is that this could sometimes mean the economy falls into deflation. That’s a risk, but based on the historical record it’s a relatively small one."

"The era of quantitative easing, however needed during the panic, was supposed to be temporary. Instead the Fed has maintained its $7 trillion balance sheet and pays interest on reserves to the biggest banks. The Fed would do better to return to its previously more modest place in economic policy." 

Powell Plans U-Turn on an Economic Strategy That Soured

The Fed unveiled a strategy five years ago for worries that the economy outgrew. Now, it will formally reset.

By Nick Timiraos of The WSJ. Excerpts:

"The 2020 changes involved two main shifts. First, the Fed said it would allow inflation to run modestly above its 2% target for periods to make up for times when it had fallen short. Second, officials said they would focus only on the unemployment rate being too high, rather than also worrying about the rate being too low, removing some urgency to pre-emptively raise rates and prevent the economy from running too hot."

"But when inflation took off in 2021, the Fed’s commitments to maintain low rates to spur a faster labor-market recovery put officials in a bind. Economic conditions could have reasonably called for rate increases later that year, but the central bank didn’t begin raising rates until March 2022.

By that point, inflation had reached levels not seen in four decades. The “raging inferno,” as one Fed official put it that year, was nothing like the modest overshoot of the inflation target the central bank had in mind.

The delay has sparked a debate among economists about what went wrong. In a detailed study last year, economists Christina Romer and David Romer at the University of California, Berkeley, argued that the 2020 framework itself was a reason the Fed acted so slowly. They concluded that officials became too focused on getting unemployment as low as possible.

“Arguably, this asymmetry contributed to a delayed response to the inflation surge of 2021-22,” said Donald Kohn, a former Fed vice chair, at a conference last year." 

Others "fault significant forecast errors made by the Fed and many outside economists in 2021—that inflation would prove so short-lived that the Fed shouldn’t adjust rates in response."

"The Fed misjudged how the U.S. economy’s capacity to produce goods and services had declined, and as a result “it kept in place an exceptionally accommodative monetary policy longer than it would have,” said Richard Clarida, who was Fed vice chair in 2020, in a lecture." 

The Lunacy of Lawfare Against the Fed

Criminalizing a spat over interest rates is an Argentina-level mistake

WSJ editorial. Excerpts:

"The complaint in MAGA quarters is that the multiyear renovation of several office buildings in the Fed’s Washington, D.C., campus is running way over budget—the cost is said to total some $2.5 billion now, up from a $1.9 billion estimate when the refurbishment started.

It’s a dubious project, with a zoning application that envisioned a new underground parking garage and concourse connecting two buildings, atria and water features, a jazzed up “executive” dining facility, and luxury finishes. It’s also not the first government building project to run over budget. And if you think this cost overrun matters to the federal budget you missed a few decimal points and commas in the One Big Beautiful Bill Act."

"Now that Congress is interested in the Fed, lawmakers have plenty of better ways to spend their time. They could debate the dual mandate (price stability, plus full employment) they handed the Fed in the 1970s, or the appropriateness of the Fed’s ample-reserves regime, its delivery of forward guidance, or its practice of paying interest on banks’ reserve balances and whether Congress could or should act to curtail any of this." 

Kevin Warsh on Fed Policy and Independence

The former member of the Board of Governors says the central bank has wandered too far from its core mission.

WSJ editorial. Excerpts:

"The Fed has undermined its own credibility in recent years by failing to fulfill its core duty of providing price stability. The central bank has also wandered far from its monetary policy mission into political areas on which it lacks expertise or justification."

"the Fed’s foray into fiscal policy. Whatever the benefits of quantitative easing in the 2008-09 financial panic, the Fed’s boundless bond purchases for many years after the crisis disguised the true cost of capital."

"the Fed in effect subsidized government deficit spending"

"The Fed has also rambled into asset allocation and controversial political questions. The Fed’s purchase of mortgage-backed securities has subsidized the real-estate market long after the housing crisis ended."

" the Fed indulged progressive political priorities on climate change and even seemed to target the jobless rate for certain demographic groups."

The Lesson of Trump vs. Powell

Their dispute is a reminder that monetary policy can’t make up for economic policy errors like tariffs

WSJ editorial. Excerpts:

"The problem for Mr. Trump is that Mr. Powell spoke the truth. Tariffs are a tax, which means higher prices for tariffed goods. Mr. Trump has imposed a minimum tariff on the world of 10%, which is roughly four times the previous average U.S. tariff rate of 2.4%."

"there’s also mounting evidence that household and business uncertainty is mounting, which will weigh on the private investment Mr. Trump needs to spur growth. Consumer spending could ebb as falling stock prices cause the “wealth effect” underpinning consumer confidence to go into reverse. Many economists think a recession is on the horizon." 

"the Fed hasn’t reached its target inflation rate of 2%, so Mr. Powell is right to be wary of trying to offset the impact of tariffs by easing money too much or too soon."

"That was the mistake the Fed made in the 1970s after Richard Nixon suspended dollar convertibility to gold and blew up the Bretton Woods monetary system."

"If the President wants faster growth and less market turmoil, he can help by ending his tariff campaign. Then get Congress to move on a tax- and spending-cut bill, and press ahead with deregulation."

WSJ’s Prof. Blinder Misses Again on Inflation Analysis

By Alexander W. Salter.

"Writing in the Wall Street Journal, Alan Blinder argues that President-Elect Donald Trump’s economic agenda will spark inflation. “Almost every economist will tell you — as many did before Nov. 5 — that Mr. Trump’s proposed policies are inflationary,” he warns. 

Blinder singles out tariffs, tax cuts, and deportations as causes. He also thinks politicizing the Fed is a concern.

But Blinder has been consistently wrong about inflation for the past four years. He failed to predict massive price hikes and misdiagnosed their cause. We have every reason to suspect he’s misleading us again. Based on his column, it seems he’s learned nothing and forgotten nothing since the COVID-19 pandemic.

Blinder correctly notes that tariffs will raise prices for American households. Tariffs cause a “one-shot price increase,” he acknowledges. However, this acknowledgement sinks his broader argument. A one-time increase in certain relative prices is fundamentally different from a sustained increase in the general price level. The latter is what economists call inflation.

Next, he says tax cuts cause inflation. This reeks of zombie Keynesianism. The argument is that increasing the government budget deficit, whether by increasing spending or cutting taxes, puts upward pressure on prices. Except it doesn’t: deficits alone can’t cause inflation. 

An increase in the deficit changes the composition of total spending, but it only increases total spending if it is accommodated by monetary policy. As the residual determiner of aggregate demand, it’s the Fed — not Congress and the President — that’s responsible for inflation. Blinder qualifies himself by predicting “only a little inflation,” but what matters is that his framework for evaluating the relationship between deficits and prices is outdated.

What about deportations? Blinder asserts they “will be inflationary by restricting the supply of US labor.” Again, far too simplistic. Deportations will reduce the labor supply, driving up wages. But illegal immigrants are not just suppliers of labor. They are also demanders of labor, through the various goods and services they consume. Immigration crackdowns will lower both the supply of and the demand for labor. The net effect on wages is ambiguous. 

Higher wages do not necessarily imply higher inflation. More likely, the wage increase Blinder predicts would result in a one-time increase in the price of some goods and services, not an increase in the general price level.

This brings us to Blinder’s least-bad argument: eroding Fed independence could result in perpetually higher inflation. Keeping the central bank independent from politics is supposedly necessary to promote responsible monetary policy. True, politicians on short-term election cycles have predictably bad incentives when it comes to interest rates and money creation. But it’s not clear that total Fed immunity, which is more or less what we have now, is any better. 

Furthermore, we can question Blinder’s commitment to safeguarding monetary policy from electoral politics. When former New York Fed President William Dudley not-so-subtly suggested the Fed tank the economy so Trump would lose in 2020, Blinder was awfully quiet. Perhaps he thinks “independence” is only necessary to protect us from Republicans.

Suppose Trump succeeds in making the Fed more beholden to elected officials. That would at least be some kind of a responsibility mechanism. Right now, there’s none. No member of the FOMC, and certainly not Chair Powell, will face any professional consequences for unleashing the worst inflation in 40 years. If the politicians have more of a say in selecting and overseeing monetary policy makers, we can meaningfully change monetary policy by throwing out the politicians every two to six years. 

Most monetary economists today believe that central bank independence results in better monetary policy. But many earlier monetary economists, including Milton Friedman, were skeptical of central bank independence. 

“Is it really tolerable in a democracy to have so much power concentrated in a body free from any kind of direct, effective political control?” he asked. There are both political and economic problems associated with central bank independence, not least of which is that “it almost inevitably involves dispersal of responsibility.” Friedman was more optimistic about “legislating rules for the conduct of monetary policy.” This would “enable the public to exercise control over monetary policy through its political authorities, while at the same time preventing monetary policy from being subject to the day-to-day whim of political authorities.” I concur.

In short, Friedman knew what central bank independence really meant: central bank unaccountability. Friedman was far from a crank. And today’s monetary economists would do well to consider his view.

Blinder’s column offers more heat than light. This isn’t surprising. Ever since Covid, Blinder’s writings have studiously ignored anything written about monetary economics and macroeconomics since 1960. The result has been consistently bad predictions. So long as Blinder doubles down on Eisenhower-Kennedy era Keynesianism, he won’t have much to offer public discourse."

A Policy for All Seasons

By Scott Sumner.

"George Selgin is the most frequent guest on David Beckworth’s Macro Musings podcast, and listening to the recent interview it’s easy to see why. I would have trouble finding a single point on which I disagree. I see Selgin as a more eloquent and better-informed version of myself.

While much of the podcast discusses issues such as Bitcoin and debanking, I’ll provide a few comments on the final portion, which covers the Fed’s upcoming monetary policy review.  Here’s Selgin:

[A]ll this stuff, from just having a plain old 2% inflation target, to having a flexible average inflation target, to having God knows what they’re going to come up with next, some acronym with inflation in it— All of this is just a way of getting to what really works, which would be targeting nominal GDP.

But they can’t say that. They don’t even want to talk about it because it doesn’t sound like the dual mandate. And this is really unfortunate, because NGDP targeting is a good way to come up with good behavior of both the inflation rate and employment. It’s a way to avoid severe unemployment. It’s a way to avoid overheating the labor market. It’s a way to gain a long run inflation rate of around 2%, but while also allowing prices to behave differently during supply shocks in a way that, again, best preserves stability in the labor market, which is the other thing you want.

It accomplishes all of those things. The one thing NGDP has going against it is it is not obviously the same thing as stable prices or high employment. It doesn’t sound like the dual mandate. So, we have to figure out, I think, what the Fed has been doing has been stumbling its way towards strategy language that sounds like the dual mandate but is actually stable NGDP. They would save a lot of time doing this, and, maybe, who knows how many more strategic reviews if they would just acknowledge what they’ve been up to and at least, secretly, talk about stabilizing spending.

Unfortunately, David Beckworth indicates that the Fed is not likely to move in the direction of NGDP level targeting.

This is a good illustration of what concerns me about where I think the framework review is going, and that is, Jay Powell sat down with Catherine Rampell from The Washington Post. They did a little interview. She asked him about the framework review, and he said, “I see as a base case,” these are his words, “A reaction function where you don’t overcompensate or you don’t overshoot for past misses.” So, effectively, he’s saying, “I see as a base case, we don’t have makeup policy.”

After 2008, the Fed screwed up by not trying to do any make-up policy.  In 2021 they screwed up in exactly the opposite direction, by doing far too much make-up, overshooting the previous NGDP trend line by 11%.  

So when you’ve made one serious error going too much in one direction, and another serious error going too much in the opposite direction, isn’t the conclusion that you should aim for somewhere in the middle—do just the right amount of make-up?  Instead, it seems as though the Fed is planning to return to the policy regime that led to the Great Recession.  How can we explain that?

The following is just speculation on my part, but it’s the only explanation that I can think of.  The Fed may be assuming that the zero rate problem is gone, and that for various reasons the (nominal) natural rate of interest will remain above zero.  Why might that be?  Perhaps some combination of slightly higher trend inflation than during the 2010s, slightly stronger real growth due to AI, and much bigger budget deficits for as far as the eye can see.  The bond market is certainly not forecasting a return to the zero lower bound.

The second calculation may be that level targeting isn’t really necessary when you are not at the zero lower bound. They may be thinking that Alan Greenspan’s policy approach worked pretty well when rates were positive, and they can safety return to inflation targeting in a positive interest rate environment.  

I don’t view that sort of reasoning as crazy, but in the end I do not agree.  First of all, NGDP targeting works better than inflation targeting even during “normal times”.  More importantly, macro history is full of unforeseen developments and thus you need a policy for all seasons.  I have no doubt that during the 1990s my students were bored when I taught them about what happened in the 1930s when there was a severe banking crisis and interest rates fell to zero.  That had never happened during their lives, or even in my (much longer) life.  “Why do we need to learn this old stuff?”  I hope that they saw the value of my teaching when they were working on Wall Street in 2008.  

You never know what sort of changes will occur in the macroeconomy.  Rather that take policy shortcuts, adopting a policy regime that might work in “fair weather”, isn’t the more responsible course of action to adopt a regime that works under almost all conditions?  Indeed, isn’t that approach more responsible even if it is slightly harder to explain NGDP level targeting to Congress than it is to explain inflation targeting?"

A New Year’s Resolution for the Federal Reserve

It should embrace clear monetary-policy rules and explain its reasoning for departing from them

By Jason Furman. Excerpts:

"the humans in charge of the central bank should be required to establish consistent operational principles and explain their reasoning when they depart from them.

At the end of 2023 the median Federal Open Market Committee member expected that 2024 would bring economic growth of 1.4%, core inflation of 2.4% and three cuts in the federal-funds rate. Instead the economy is on track for about 2.5% growth and 2.8% core inflation. With the economy much stronger than expected and inflation more persistent, the Fed should have scaled back its rate moves."  

"insofar as the Fed has substituted its judgment for rules, the rules look better than the judgment. The Fed wouldn’t have needed so many supersize hikes in 2022 and 2023 had it followed any version of a Taylor rule, which would have called for rate increases starting in 2021 based on inflation and the unemployment rate. The initial progress on inflation in the second half of 2023 would have led to an earlier adjustment in rates without the need to catch up with a supersize cut in September 2024."

"the Fed should pick one rule, or a suite of rules, and publish what it would dictate at every FOMC meeting. If the committee chose a different course than the rule or rules would recommend, it would have to explain what judgments led it to do so."

"to the extent the Fed departs from its rule over time, it must do so without prejudice. It is always too tempting to find excuses for why rates should be lower rather than higher. At any given time that may be true, but it adds up to an inflationary bias in monetary policy."

"Placing more weight on rules at the Fed could solve several problems. It would make monetary policy more predictable and understandable, reducing market volatility and enabling better investment decisions. It could also avoid the biases that have crept into the Fed’s decision-making in recent years."

The Fed Admits an Inflation Mistake

Yet the central bank still cuts its target rate by another 25 basis points. Its explanation isn’t convincing

WSJ editorial. 

"Well, that was ugly. We mean the big selloff in stocks and bonds Wednesday following the Federal Open Market Committee’s decision to cut its target interest rate by another 25 basis points. 

Wall Street is calling this a “hawkish cut” because the Fed’s potentates rolled back their expectations about future rate cuts. But the real way to think about Wednesday’s monetary news is that the Fed now all but admits it has underestimated the staying power of inflation.

In September, Fed Chairman Jerome Powell sounded like a man who thought he’d whipped inflation when he cut rates by 50 basis points. Long bond rates popped after that Fed meeting in a vote of skepticism. But Mr. Powell plowed ahead anyway with another 25-point cut in November.

Wednesday’s cut takes the fed funds rate down to 4.25%-4.5%, but at the same time Fed officials revealed that they think inflation isn’t falling and will rise next year by more than they anticipated. The Fed’s favorite price measure—personal consumption expenditure inflation—will rise to 2.5% next year, up from a 2.1% forecast in September, according to the Fed’s famous “dot plot” projections by governors and Fed regional bank presidents.

This makes that 50-basis-point cut in September look like a mistake. Worse, policy makers now expect it will take until 2027 to hit the Fed’s 2% annual target, a milestone they thought in September they’d be able to achieve in 2026. While the FOMC’s rate cut signaled easing, the dot plots signaled less easing—only two cuts next year compared to four predicted in September.

Mr. Powell was also far from clear in his justification for the rate cut. While he called it a “closer call” than recent decisions, he explained one goal was to prevent the jobless rate from rising any more. With inflation no longer falling as he thought, this suggests he and the Fed are willing to live with higher inflation for a longer period of time.

Markets got the message, as bond yields rose and stocks took a header, with the Dow Jones average falling 2.58% and the Nasdaq 3.56%. The 10-year Treasury hit 4.52%.

There’s also evidence that some at the Fed didn’t agree with the FOMC rate cut this time around. The dots suggest four officials wanted to stand pat on Wednesday, though only Beth Hammack of the Cleveland Fed formally dissented. The other three may have been regional Fed bank presidents who don’t have votes on the FOMC this year, or perhaps one or more board governors swallowed their skepticism to unite behind Mr. Powell when it came time to vote.

Mr. Powell and his mates bet on a smooth disinflation path to their 2% target, but prices aren’t cooperating. This raises doubts about whether the Fed really knows when its policy is tight. Financial conditions haven’t looked tight to us, and Wednesday’s message is that some at the Fed may agree."

Has the Fed Learned Any Lessons?

The central bank wants to declare victory over inflation but hasn’t explained its monetary mistakes

WSJ editorial. 

"The Federal Open Market Committee meets this week, and investors are speculating whether Federal Reserve Chairman Jerome Powell will cut interest rates by 25 or 50 basis points. We have a different question: Has the Fed learned anything from its inflationary debacle?

As the central bank pivots from its tightening cycle, Fed triumphalism is in the air. Inflation is said to be vanquished, the fabled soft landing has arrived, and Mr. Powell and his mates are hailed as financial heroes. The Fed can now get back to the business that Wall Street and the financial press want, which is cutting rates (50 points please!) and getting the financial party restarted.

***

Sorry to be a spoilsport, but humility is more appropriate than hagiography. The Fed has made considerable progress in reducing inflation from its 9.1% peak in June 2022, and for that it deserves credit. But no one should forget the monetary mistakes that led to the worst inflation in 40 years. 

The Fed calculated that it could monetize an unprecedented peacetime government spending blowout without triggering inflation. When inflation did begin to accelerate, the central bank said not to worry. It was “transitory,” the result of supply-chain obstacles caused by the pandemic. So the Fed stayed too easy for too long—the same mistake it made in the mid-2000s that fed the housing boom that turned to bust and the financial panic.

No one should forget either the cost this inflation burst has imposed on average Americans in a lower standard of living. The price of nearly everything is higher—about 20% higher overall since January 2021—while real wages haven’t kept up. Prices are rising less rapidly now, but they aren’t going back down. Housing is also much less affordable in part because interest rates had to rise to reduce inflation.

This has meant real hardship for tens of millions of wage earnings without nest eggs in financial or real-estate assets. The Fed’s grand monetary experiment since 2008—near-zero interest rates, bond-buying to keep long rates low—have been wonderful for Wall Street and the wealthy. They haven’t been nearly as great for the middle class that survives on salaries and meager savings.

The Fed nonetheless feels it’s time to ease money again, and at this point it has little choice. Failing to cut rates this week would hurt the Fed’s credibility after so much signaling. But some humility would help here too, as the Fed navigates a return to its 2% target that it still hasn’t reached.

While the labor market has softened, overall financial conditions aren’t all that restrictive. There’s plenty of liquidity around, equity prices have boosted the wealth effect on consumer spending, and the prices of gold and other commodities are up. The Chicago Fed’s financial conditions index has been signaling easier conditions of late as well.

Mr. Powell has also been signaling, and may announce soon, a further slowing in the pace of quantitative tightening (QT). Thus it appears the central bank’s balance sheet will remain permanently larger than it was before 2020. This is supposed to allow the Fed to meet commercial banks’ increased demand for reserves. But the looming end of QT is also another signal that easier money is coming. Does this mean that the era of vast bond-buying is here to stay, to be triggered again at the first sign of an economic slowdown?

We don’t agree with those who say a cut in rates this week is political or intended to help Kamala Harris. The real risk for the Fed is if it embarks on a monetary easing cycle that stops the current disinflation and causes prices to rise again. This would do far more harm to the Fed’s credibility than disappointing financial markets with a slower pace of rate-cutting than Wall Street aches to see.

***

The larger point is that Fed officials haven’t shown much evidence of introspection over what caused inflation—or for that matter why it has come down without triggering a recession. Mr. Powell took a cautious stab at it in his recent Jackson Hole speech. But his analysis leans heavily on the supply-chain disruptions of the pandemic and excessive spending that boosted demand.

There wasn’t much if any reflection on the Fed’s role, or why its internal models were so wrong on the direction of the economy and prices. In the end he seems to blame “the pandemic economy” that “has proved to be unlike any other.” Perhaps so, but that isn’t reassuring about the future of monetary policy.

Whatever Mr. Powell does, better to keep the corks in the champagne bottles until we know the Fed’s moves have worked—or, better yet, why and how."

Monetarists Warned of a Recession

To get ahead of the curve, the Fed should follow the quantity theory of money

To get ahead of the curve, the Fed should follow the quantity theory of money. 

"The tide has suddenly turned on the economics consensus among everyone from Keynesian professors to Wall Street commentators. Their expectations for a soft landing have fallen to earth.

The immediate trigger for the shift and the selloff in equity markets was a run of adverse data last week. It began on Wednesday, with higher claims for unemployment insurance, followed on Thursday by weak purchasing-manager indexes for manufacturing and services. Then on Friday came disappointing nonfarm payroll data and a higher than expected unemployment figure.

lain why the consensus changed so fast, the economic chattering classes and press have latched onto the Sahm rule. That tool, created by economist Claudia Sahm, correlates an increase in unemployment with the onset of recessions. According to Ms. Sahm’s research, if the unemployment rate climbs by half a percentage point or more relative to its low during the previous 12 months, we will be in the early months of a recession.

This index has identified all recessions since 1953, but Ms. Sahm rightly emphasizes that the rule is only an empirical regularity, not a theory. Since January the unemployment rate has risen from 3.7% to 4.3%, fulfilling the Sahm criterion of a 0.5-point rise. The 3.7% low qualified, as it represents a low that has occurred within the past 12 months. This suggests the economy may already be in a recession.

The Federal Reserve was having none of it last week. On Wednesday, the Federal Open Market Committee held the federal-funds rate steady at 5.25% to 5.5%. Chairman Jerome Powell and his colleagues are data dependent. Until the data give them confidence that inflation will stay low, or until their full employment objective is threatened, they won’t cut rates. Since we know that changes in monetary policy act with a long lag in affecting inflation or unemployment, a data-dependent Fed will always be behind the curve.

To get ahead of it, the central bank should be basing its decisions on the quantity theory of money, a model that allows for reliable predictions about the course of the economy and inflation over the coming two years. The only people who successfully predicted inflation almost two years ahead of its peak—both in terms of timing and magnitude—were monetary economists.

For more than a year, monetarists have been warning that the economy would likely enter recession this year. That is because the Fed has over-constricted money growth between 2022 and 2024. The stock of money is now lower than it was in July 2022. Since the Fed was established in 1913, such contractions have only occurred on four occasions: in 1920-22, 1929-33, 1937-38 and 1948-49. The second episode resulted in the Great Depression, and recessions followed the other three."

Fed Dot-Plot Forecasting Fiascos: June 2008 and June 2021

By Alan Reynolds.

"The Federal Reserve chairman and Federal Open Market Committee (FOMC) always imagine that they can prevent recession by anticipating trouble in time to stop it. If that were true, soft landings would be the norm rather than a freak rarity.

At his July 31 press conference, Fed Chair Jerome Powell remarked, “We know that reducing policy restraint … too late or too little could unduly weaken economic activity and employment.… If the labor market were to weaken unexpectedly, we are prepared to respond. Policy is well positioned to deal with the risks and uncertainties that we face.” 

Prepared and well positioned? That would be a unique surprise. The Fed has an almost perfect record of raising the federal funds rate on bank reserves only after inflation surges are well underway. And it has an even better record of cutting interest rates only after recessions are likewise underway, always too late and usually too much.

Was the Fed prepared and well positioned to deal with unexpectedly high inflation from the second quarter of 2021 to the second quarter of 2022? From October 2008 to May 2022 the federal funds averaged 0.5 percent and was almost always near zero (rising above 2 percent only from October 2018 to September 2019). The Fed did not respond at all as the year-to-year personal consumption expenditures (PCE) inflation rate rose to 4.1 percent in the second quarter of 2021, 4.7 percent in the third, and 5.9 percent in the fourth. By the second quarter of 2022, inflation reached 6.8 percent. Yet the fed funds rate in 2022 was only 1.2 percent in June 2022, 1.7 percent in July, and 2.3 percent in August.

Conversely, when it comes to “reducing policy restraint” to prevent recessions, consider what happened in 2008. By June 2008, the economy had been in recession for six months, but no Fed governor or regional bank president expected even a future recession in their June dot-plot “projections” for 2008–2010. Even when the oil shock recession was aggravated by financial crisis in the next two months, the FOMC remained unprepared to act.

This is what happened in 2008 and how the Fed reacted, as documented by the New York Times:

• August 5: “The F.O.M.C. holds interest rates steady. It frets that inflationary pressures are building. Three of the regional reserve banks want to raise interest rates.”
• September 7: “The Federal Housing Finance Agency places Fannie Mae and Freddie Mac in government conservatorship.
• September 15: Lehman Brothers files for Chapter 11 bankruptcy protection; Bank of America buys Merrill Lynch.”
• Sept. 16: “The F.O.M.C. continues to hold steady on rates. Most Fed officials say they still believe the economy is growing, still predict it will grow in the final months of 2008 and grow more quickly in 2009. And they still fret that inflation is rising.”

Previously, at a Federal Reserve policy meeting on November 20, 2007, a month before the Great Recession began, the FOMC introduced a new quarterly Summary of Economic Projections (SEP). These highly publicized quarterly projections, from Federal Reserve governors and reserve bank presidents, became famous as a scatter diagram called the “dot-plot.”  Barely seven months after the November 2007 launch, however, this new FOMC central planning ritual failed spectacularly.

The SEP dot-plot projections from June 12, 2008, are shown in Table 1. By that time, the economy had already been in recession for half a year. Yet nobody at the FOMC in mid-2008 imagined recession was a serious threat. Indeed, “some participants pointed to the apparent resilience of the US economy … and suggested that the adverse effects of financial activity outside of the housing sectors could prove more modest than expected.”

SEP tables reveal participants’ projections of the percentage change in real GDP and PCE inflation between the fourth quarters of each year. They also post the unemployment rate expected in the last quarter.

The top panel in Table 1 instead highlighted the “central tendency” of these estimates in June 2008. Instead of using a median as an average (which became common later), this “trimmed mean” eliminated the highest and lowest three. To emphasize that not one of the projections was remotely close to being right, I prefer to focus on the bottom panel—which shows the entire range of estimates for all 12 participants.

Meeting in the middle of 2008, with half the year behind them, not one of the June 2008 FOMC projections imagined the 18-month recession that started that January would happen at any time in 2008, 2009, or 2010. Projections of real gross domestic product (GDP) growth by year-end ranged from 0.9 percent to 1.8 percent. Yet actual real GDP growth in 2008 was sharply negative—down 2.5 percent by the fourth quarter. For 2009, the Fed’s June 2008 projections expected real growth of 1.9 to 3.0 percent. But economic growth in 2009 was roughly zero, 0.1 percent.

The June 2008 FOMC SEP projected PCE inflation of 3.4 to 4.6 percent between the fourth quarters of 2007 and 2008. But actual inflation was only 1.2 percent in 2008 and 2009.

The unemployment rate in the June 2008 dot-plot was projected to be 5.5 to 5.8 percent in the fourth quarter of 2008, and 5.2 to 6.1 percent in the fourth quarter of 2009. But the unemployment rate reached 6.9 percent by the last quarter of 2008 and 9.9 percent by late 2009. Unemployment remained above 9 percent until the end of 2011 and did not return to pre-recession levels until 2014.

Table 1: FOMC summary of economic projections, June 2008

The Fed has only once managed to keep the federal funds rate above 5 percent for a long time without recession, from November 1994 to November 1998 (even as PCE inflation fell from 2.1 percent in 1994 to 0.8 percent in 1998). Before that, the longest such “higher-for-longer period” experiment with such a high central bank interest rate lasted only 14 months—when the New York Fed kept the discount rate at 5–6 percent from August 1928 to October 1929. That ended with the Great Depression.

The FOMC’s third major experiment with a higher-for-longer strategy lasted from June 2006 to September 2007, when the federal funds rate was kept above 5 percent for over a year. That ended with the Great Recession.

The latest higher-for-longer Fed marathon, which began August 2023, is now almost a year old and still being tested.

The 2008 Fed projections were dangerously slow to react to the unfolding recession, remaining strangely more concerned about an assumed inflationary impact of a global oil price spike. They forgot that oil price spikes are reliable omen of recession (and of Fed mistakes). High oil prices and a high fed funds rate preceded every postwar US recession since 1957 except one (1960). Oil prices and the fed funds rate spiked before the recessions of 1957, 1970, 1974, 1980, 2001, and 2008.

Figure 1: Weekly oil prices and the federal funds rate 2007–2014

As Figure 1 shows, shortly after the June 2008 FOMC meeting, on the week ending July 4, the spot price of West Texas Intermediate (WTI) crude oil peaked at $142.52 a barrel, and the fed funds rate was 2.2 percent. Oil then fell to $97.19 by the week ending September 19, and the Fed cut the funds rate below 1.3 percent.

By Christmas 2008, WTI crude reached a weekly low of $32.98, and the Fed fund rate had been slashed to essentially zero (0.14 percent) where it remained until May 2022, aside from October 2018 to September 2019.

The hubris of central banking relies on what F. A. Hayek called “the pretense of knowledge.” Like the quaint central planners of socialist fantasies, the pretense is that a dozen experts can somehow steer the entire US economy with a tiny rudder—the overnight “policy rate” paid to banks for holding reserves at Fed district banks. Even if that worked as planned, it requires forecasts because using past data to set future policy is doomed by the long and uncertain lags between Fed actions and business and household reactions.

Just as the FOMC was astonishingly slow to react to the inflation surge in 2021and early 2022, they were equally blindsided in 2008 by another oil price shock recession—despite the Fed having repeatedly made the identical blunder in other recessions of keeping interest rates high because oil prices were high.

Keeping Fed policy unchanged until the Fed’s committee could agree about obvious risks of inflation or recession caused costly procrastination errors in 2008 and again in 2021–2022.

Top Fed officials today apparently remain as confident as they were in mid-2008 that they will get it right this time—by reacting to “the data” in plenty of time to avoid a recession. But economic data looks backwards, not forward. Because monetary policy works with a long lag, Fed policy must be based on forecasts. Unfortunately, FOMC forecasts have a dismal record."

The Hard Lessons of Easy Money

See Politics: Ruchir Sharma’s ‘What Went Wrong With Capitalism’ Plus Rainer Zitelmann’s ‘How Nations Escape Poverty.’ by Barton Swaim. He reviews two books. Excerpts:

"Mr. Sharma’s contention: In the mid-1970s, the Federal Reserve began flooding the U.S. economy with money to ward off any hint of downturn; the private sector responded by taking on unnatural levels of debt; and Congress and regulators adopted the attitude that any big company looking wobbly had to be rescued. Meanwhile every part of government grew—even during the 1980s, when progressives claim it shrank. In time, the U.S. government created a kind of safety net for large corporations, which increasingly put their resources toward lobbying and other forms of self-protection.

That deficit spending tends to encourage growth is, of course, a core tenet of Keynesian economics. But John Maynard Keynes’s original prescription, Mr. Sharma reminds us, was that governments should borrow and spend to counter weak demand in hard times but to save in good times in order to manage the next downturn. Policymakers over the past half-century, however, have rejected the saving part of Keynesian doctrine and felt that they had to juice the economy in good times, too.

Leave aside the obvious and overwhelming consequences for the U.S. government—$34 trillion in debt, massive and permanent peacetime deficits, $800 billion-plus spent on interest alone, and so on. The consequences for economic growth are equally dire. Here Mr. Sharma, chairman of Rockefeller Capital Management’s international business, makes the book’s most important point. For decades liberal economists ridiculed anyone who claimed that lowering government spending would improve overall economic growth or who doubted that pumping money into the economy was good for growth. More money in the economy, they pointed out, by definition expands it; how is that not pro-growth? As years went by and no calamity arose from constant deficit spending, the Keynesians seemed to have further reason to laugh at their critics.

But the real effect of easy money and permanent deficits, Mr. Sharma contends, is long term: financial markets distorted by trillions in misallocated capital. Decades of loose monetary policy have made the American economy—and the same is true of the other debt-soaked economies of the developed world—chronically lethargic. Multinational corporations, which, in an easy-money economy, can live on debt for years, have put more and more of their resources into activities that have nothing to do with their products and services. “The United States now has one manager for nearly every five workers,” Mr. Sharma writes. “The C-suite has expanded to include Chief Officers of everything from Analytics and Digital to Collaboration, Customers, Ethics, Sustainability, Learning, and Happiness. And every chief needs his or her administrative minions.”

The macroeconomic upshot: Recessions happen rarely, but growth and productivity are almost always anemic."

"No one’s going to complain about the infrequency of recessions, but Mr. Sharma makes a strong case that they can have what economists Ricardo Caballero and Mohamad Hammour once called a “cleansing effect,” in which badly managed and unproductive companies die or get folded into better ones."

"the German social scientist and entrepreneur Rainer Zitelmann, in “How Nations Escape Poverty: Vietnam, Poland and the Origins of Prosperity,” relates what happens when poor nations with onerous planned economies scrap their plans and open themselves up to trade.

The depth of poverty into which the victorious communists plunged Vietnam after the fall of Saigon in 1975 would be difficult to exaggerate. Once an exporter of rice, by 1980 it couldn’t grow enough to sustain its own population. For several years Vietnam was almost the poorest nation in the world. In 1986 the ruling party—which, unlike some Western governments one might name, had sense enough to see what wasn’t working—began a series of reforms known as Doi Moi (“innovation” or “renovation”). The regime lifted restrictions on private manufacturing, abolished internal customs checkpoints, eliminated most subsidies and price controls, denationalized businesses, and returned land that the state had confiscated. 

The turnaround wasn’t instant, but nearly so. GDP growth shot up to 7% or 8% in the 1990s, rates of poverty plummeted and life expectancy improved. By the mid-2010s, Vietnam had become, despite continuing restrictions on speech and other freedoms, one of Southeast Asia’s largest manufacturing hubs. 

Mr. Zitelmann tells a similar story of economic unshackling in Poland, which in the space of three decades went from one of Europe’s poorest states to one of its wealthiest, in time besting some European nations that had never fallen under Soviet control. I hold no brief for Vietnam’s political class, which still considers itself communist. But the recent histories of both Vietnam and Poland teach the same lesson: that a nation can do wonders when it stops trying to manage itself into perfection and shield its citizens from risk."

Bidenomics, Also Known as MMT

The crazy economic theory that spending has no consequences

By Arthur Laffer and Stephen Moore. 

"Sometimes ideas that seem obviously silly catch on and cause serious destruction. In the late 2000s Australian economist Bill Mitchell coined the term “Modern Monetary Theory,” or MMT, to describe what one might call Keynesianism on steroids. John Maynard Keynes (1883-1946) argued that government should stimulate the economy by spending and borrowing during a short-term shock like an economic crisis or a war, then pull back to a reasonable level of spending and debt once the crisis has passed.

Under MMT, the crisis never ends. Proponents posit that because the dollar is the world reserve currency and the Treasury can sell bonds at low interest rates, Uncle Sam can spend and borrow limitlessly with no economic risk. As Stephanie Kelton, an economist at Stony Brook University, put it: “Deficits can help us fight a myriad of problems that plague our economy—inequality, poverty and unemployment, climate change, housing, health care, and more.”

Free-market economists scoffed. History is littered with nations that tried to spend and borrow their way to prosperity: ancient Rome, interwar Germany, Argentina, postwar Britain, and more recently Bolivia, Mexico, Zimbabwe, Greece and Venezuela.

But on the left, MMT caught on as an explanation for why Barack Obama’s nearly $800 billion stimulus plan in 2009 failed to yield anything like the promised 4% annual growth. They said the spending wasn’t enough.

In 2020 the Democratic Party fully embraced MMT. Ms. Kelton served as a top economic adviser to Sen. Bernie Sanders, runner-up for the party’s nomination, and later co-authored a report for the Biden campaign that served as a blueprint for its spending blowout. In 2021 MMT gave the administration and Democratic lawmakers an academic imprimatur for the avalanche of spending, four times as large as Mr. Obama’s stimulus 12 years earlier.

Donald Trump had already unwisely presided over a Covid-relief spending spree. Mr. Biden persuaded Congress to shovel $4 trillion into social-welfare programs, corporate-welfare grants, leftist environmental programs, college and healthcare subsidies and more. In a testament to MMT’s sway, 17 Nobel economics laureates signed a 2021 statement asserting that all this spending “will ease longer-term inflationary pressures.”

Never mind that the economy was already bouncing back as businesses reopened. Mr. Biden and the MMT crowd thought they had invented a perpetual-motion machine. Instead, they unleashed the worst inflation in 40 years.

Average weekly earnings of employees rose 15% between January 2021 and May 2024. But that was a loss in real terms, since prices were up 19%. Even with trillions in handouts, working Americans have seen their average real annual income decline by more than $2,300 in today’s dollars. To our knowledge, not one of those Nobel economists has issued a retraction."