monetary policy

6 01, 2025

Karen Petrou: Oval Office Bluster at a Time of Fed Confusion

Shane Smith2025-01-06T09:08:37-05:00January 6th, 2025|The Vault|

There is no doubt after last year’s last-minute debacle that U.S. fiscal policy is in still tinier tatters. But, unnoticed so far is the still greater danger of confused fiscal policy combined as it now is with feckless monetary policy. An economy resting on fiscal- and monetary-policy disarray is an economy at grave risk that sure-and-certain volatility will break through fragile guardrails. Strained financial systems could then quickly compound the inflationary pressures likely from Trump trade and fiscal policy along with an array of supply-chain and employment risks. And these are just the slow-burning hazards. What happens if the financial system is shocked?

Although there has long been much about Fed policymaking that strains credulity, global financial markets have looked to the Fed as to a star in the East. After 2008, markets had so much faith in the Fed that it was rightly dubbed “the only game in town” in a highly-influential 2016 book. Now, though, investors and traders are increasingly fearful that, while the game based on Fed actions is still being played with its usual ferocity, there’s no longer an umpire or safety net.

Like adolescents suddenly facing the fact that parents are far from infallible, markets have had a rude, hard awakening in 2024’s last quarter. Much has been written in recent weeks about the Fed’s steadfast assertion that it’s “data-driven” even as its decisions veer wildly from easing to tightening and back again. That a stalwart Democratic economist recently endorsed longstanding Republican calls for …

Karen Petrou: What the Fed Must Do to Make Monetary Policy Work

Shane Smith2024-08-19T09:22:53-04:00August 19th, 2024|The Vault|

Later this week, monetary-policy disciples – at least those who agree with the Fed – will gather around the campfire atop Jackson Hole to ponder the question set before them: whether monetary-policy transmission has been effective and, since it’s awesomely obvious it hasn’t, what might be done about that. The plan is clearly to float trial balloons in the clear mountain air to see if the Fed’s thinking about the new plan slated for 2025 is any better than that which lay behind its disastrous 2019 monetary-policy rewrite. Those allowed into these August precincts will have much of value to say this time around much as they sought to do the last time the Fed asked for all their views. Odds are, though, that Jackson Hole will not consider three non-econometric phenomena that lie behind recent policy misfires: economic inequality, NBFI migration, and the strong counter-cyclical impact of Fed supervisory policy.

Why do these matter so much?

First to economic inequality. The last time the Fed rewrote its monetary-policy model, it deigned to consider economic inequality, but promptly dismissed any reasons to worry. There were, though, lots of them.

The 2019 inequality exercise suffered from the same problem as most Fed models: reliance on representative-agent, not heterogeneous data showing distributional disparities. This approach thus reaffirmed blithe convictions that anything that keeps employment high and inflation in check is good for lower-wealth and -income households because it’s good for everyone else. See my book for why that’s grievously wrong and recent …

Karen Petrou: Why Congress will Try to Recapture Fed Payments to Banks in 2023 and Why It Can’t

Arezou Rafikian2023-01-03T16:13:39-05:00January 3rd, 2023|The Vault|

Among the unmourned victims of 2022 is to be found modern monetary theory. Although it seemed clear from the start that MMT was a product of magical thinking, it engendered insouciance that kept fiscal deficits rising ever higher. Now, Republicans will press for fiscal austerity. Democrats will fight back, but they too will seek as much fiscal constraint as compatible with gaining power in 2024. Congress thus will look for new revenue sources that aren’t taxes and quickly find one at the Fed on which both sides agree: cutting payments to the nation’s biggest financial institutions.

It is difficult to calculate just how much the Fed is sending back over the transom into the financial system. One recent paper estimates it as over $100 billion a year and this might well be the case once interest on bank reserves is totaled up with the interest the Fed pays within the gigantic overnight reverse repo program (ONRRP). Whatever the sum now, it’s large and it will only go up in 2023. The more rates rise, the more the Fed pays out even as it is still saddled with billions of low-yield portfolio assets.

These interest payments are already on the radar of at least one conservative analyst. His arguments channel those Republicans raised when these interest payments were last on the fiscal chopping block, a time when Democrats also said pretty much the same about wanting billions for taxpayers, not banks.

To be sure, nothing came of all these …