“…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
“…reminds us that inequality sends a signal of what society lacks most, in America’s case, entrepreneurship and risk taking.” - Lawrence Lindsey, CEO, The Lindsey Group, former Director of the National Economic Council
“…a fresh argument for the productive value of inequality.” - David Autor, Professor of Economics, Massachusetts Institute of Technology
“…a comprehensive explanation of the modern economy.” - Julian Robertson, Founder, Tiger Management
“…a must-read for serious students of economic policy.” - Glenn Hubbard, Dean, Columbia Business School, and former Chairman of the Council of Economic Advisers
“…a comprehensive explanation of the modern economy.” - Julian Robertson, Founder, Tiger Management
“Unintended Consequences is full of substance, it is one of the must-read books of the year, and once I finish it I will be giving it a second read through right away.” - Tyler Cowen, Professor, George Mason University
“Unintended Consequences provides a provocative interpretation of the causes of the global financial crisis and the policies needed to return to rapid growth. Whether you agree or not, this analysis is well worth reading.” - Nouriel Roubini, New York University; Chairman, Roubini Global Economics
“…a very valuable contribution.” - Larry Summers, former Secretary of the Treasury and director of the National Economic Council, president emeritus, Harvard University
“There are an amazing number of good ideas and interesting points made in Unintended Consequences. The thinking underlying it, and the obvious depth of understanding of the author, are very impressive.” - Steven Levitt, coauthor of Freakonomics; 2004 John Bates Clark Medal
“…serious thinking for serious thinkers. …a thought-provoking blueprint for growing middle- and working-class incomes.” - Mitt Romney, former Governor of Massachusetts
“…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
AI Summary.Across countries and over time, higher public debt burdens are associated with lower relative returns on government bonds, the opposite of standard risk-premium predictions. The authors estimate financial repression—making banks captive bond buyers and loading them with low-return reserves—contributed 90.7 percentage points of GDP to Britain's postwar debt reduction, versus 20.3 from surprise inflation.
Marijn Bolhuis, Jakree Koosakul, Neil Shenai, and Jie YangInternational Monetary Fund
Date Posted:
Historically, sovereign yields fell relative to private returns as debt rose, driven by liquidity and portfolio rules creating captive buyers for government liabilities. Peaking in WWII, such financial repression may return as debt rises.
How do governments reduce high public debt burdens without inflation or surpluses?
Core argument: Financial repression contributed an estimated 90.7 percentage points of GDP to Britain's debt reduction in 1945–55, versus 20.3 points from surprise inflation and 3.9 points from primary surpluses.
Across countries and over time, higher public debt burdens are associated with lower relative returns on government bonds—the opposite of what standard risk premium models would predict (Figure 1a). At postwar peaks, relative yields fell to about −4% in Britain as debt neared 250% of GDP and −3% in the US; Japan later repeated the pattern (Figures 1b–d). Fiscal repression makes banks captive bond buyers; monetary repression places low-return reserves on their balance sheets (Table 1). Both indicators peaked after WWII, fell with liberalisation, and rose after the GFC (Figure 4). Repression contributed an estimated 90.7 percentage points of GDP to British debt reduction in 1945–55, versus 20.3 from surprise inflation and 3.9 from primary surpluses (Table 3; Figure 11). Cumulative savings averaged 9.8 points of GDP across advanced economies in 2008–20 (Table 3).
Takeaways by Macro Roundup® AI
Financial repression contributed an estimated 90.7 percentage points of GDP to Britain's debt reduction in 1945–55, versus 20.3 points from surprise inflation and 3.9 points from primary surpluses.
Higher public debt burdens are associated with lower relative returns on government bonds across countries and over time, the opposite of standard risk premium predictions, with postwar relative yields falling to about −4% in Britain as debt neared 250% of GDP and −3% in the US.
Fiscal repression makes banks captive buyers of government bonds while monetary repression places low-return reserves on bank balance sheets; both indicators peaked after WWII, fell with liberalisation, and rose after the global financial crisis, with cumulative savings averaging 9.8 points of GDP across advanced economies in 2008–20.
Related Articles:
The United States Capital Structure— Because Social Security and Medicare benefits are politically untouchable, retirees effectively hold the most senior claim on US government resources while Treasury bondholders hold the riskiest one. On this argument, bondholders absorb adverse fiscal shocks through surprise inflation, financial repression, or both.
The Global Fiscal Train Wreck— Ten-year forward yields ten years ahead have risen across major advanced economies, not just the US, a global theme the author attributes to the debt buildup during the pandemic. The author argues economies have begun shifting from a good to a bad debt equilibrium, which he sees behind the rally in precious metals prices tied to a "debasement trade.
Fiscal Dominance and the Return of Zero-Interest Bank Reserve Requirements— Fiscal dominance requires governments to fund deficits at the margin with non-interest-bearing debt, and the revenue from inflation taxation—both expected and unexpected—is limited. The authors argue a US fiscal dominance episode could end the payment of interest on bank reserves and restore requirements that banks hold large zero-interest reserves against deposits.
AI Summary.Emerging-market central bank reserve diversification into gold, following the freezing of Russia's reserves, anchors a forecast of $4,900 per troy ounce by end-2026, with risks skewed to the upside. Near-term headwinds include reduced demand for currency-debasement hedges and rate-sensitive exchange-traded fund demand if the Federal Reserve turns hawkish.
Gold is up 123% since 2022. GS argues it still has room to run, due to EM central bank buying and private diversification driven by worries about Western fiscal sustainability. They have a price target of $4,900/toz by the end of 2026.
Does central bank reserve diversification support further gold price gains?
Core argument: Gold has risen 123% since 2022, and the authors forecast $4,900/toz by end-2026, anchored structurally by emerging-market central bank reserve diversification following the 2022 freezing of Russia's reserves.
Despite gold’s strong rally since 2022 (up 123%), we continue to see further upside, driven by both structural and eventually cyclical factors. Structurally, EM central bank diversification--following the 2022 freezing of Russia’s reserves--remains the anchor of our $4,900/toz end 2026 forecast. While the pace of central bank gold purchases has moderated to ~50 tonnes/month on a 3-month (seasonally adjusted) and 12-month moving average basis, we view the ongoing diversification trend as structural. Cyclically, however, gold faces near term headwinds from the potential hit to demand for macro policy hedges (as a hawkish Fed helps fade the debasement theme) and as markets are pricing in Fed hikes this year amid inflation concerns, weighing on rate-sensitive ETF demand. We expect these headwinds to at least partly reverse over time. Over the medium term, risks to our gold price forecast remain skewed to the upside on the net. Gold's share in private portfolios remains small, and the Iran episode -- together with broader geopolitical developments -- may eventually accelerate private diversification into gold, including by weighing on perceptions of Western fiscal sustainability.
Takeaways by Macro Roundup® AI
Gold has risen 123% since 2022, and the authors forecast $4,900/toz by end-2026, anchored structurally by emerging-market central bank reserve diversification following the 2022 freezing of Russia's reserves.
Central bank gold purchases have moderated to roughly 50 tonnes per month on both 3-month seasonally adjusted and 12-month moving average bases, a diversification trend the authors still view as structural.
Gold faces near-term headwinds from a hawkish Federal Reserve fading the debasement theme and from markets pricing Fed hikes amid inflation concerns, weighing on rate-sensitive ETF demand.
Related Articles:
Gold Heads For Worst Quarter In More Than A Decade As Retail Frenzy Fades— Gold fell below $4,000 a troy ounce, down nearly 14% over three months, its worst quarterly performance in more than a decade after reaching a record high near $5,595. Analysts attribute the decline to expectations of US interest rate rises, outflows from gold-backed funds, traders shifting into AI stocks, and Chinese bank restrictions on retail bullion trading.
The Debasement Trade Is Unraveling and Kevin Warsh Is One Big Reason— The "debasement trade" — favoring gold and Bitcoin over a dollar seen as vulnerable to inflationary, fiscal and monetary excess — has been a defining market narrative, but a new Federal Reserve chairman's emphasis on price stability as the overriding priority lifted the dollar and long-dated Treasuries at the expense of gold and crypto.
Global Debt Report 2026— Gross central government borrowing across OECD countries rose 7% to a record $17tn, about 23% of GDP, and is projected to reach roughly $18tn, or 24% of GDP. The United States and Japan account for close to 80% of the area's refinancing requirements, with the US share rising from 57% to 70%.
AI Summary.Half of the 18 Federal Reserve policymakers submitting interest rate projections penciled in at least one rate hike, and the median projection for core inflation rose to 2.5%. The authors still expect no hikes and argue that reduced Federal Reserve transparency could make financial conditions and economic outcomes more volatile.
Jan HatziusGoldman Sachs
Date Posted:
GS notes “half of 18 participants submitting rate projections penciled in one or more rate hikes in the remainder of 2026”, though GS is holding its projection at zero. Warsh’s opposition to forward guidance was not a surprise, but its intensity was.
Does less central bank transparency make financial conditions more volatile?
Core argument: Half of the 18 FOMC participants submitting interest rate projections penciled in one or more rate hikes for the remainder of 2026, and the median core PCE inflation projection for 2027Q4 rose to 2.5%.
The first FOMC meeting under Chairman Warsh was more hawkish than expected. Half of the 18 participants that submitted interest rate projections penciled in one or more rate hikes in the remainder of 2026, and the median projection for core PCE inflation in 2027Q4 rose to 2.5%. While this has increased the upside risks, our baseline forecast remains for no hikes.We think [hikes] are less likely than markets are pricing [Exhibit 5]. We had expected Warsh’s refusal to provide either a “dot” or verbal guidance about upcoming rate decisions, but his broader comments on Fed communications with financial markets went further: “So I think financial markets perform best when they react to incoming data.The more that markets are paying attention to what's happening in the real economy, deciding what’s good data and what’s less good data, the more financial markets can price what they believe is the most likely and what are the tail risks.” Since the Fed essentially controls short-term interest rates and the interest rate path matters for asset pricing, it is inevitable that markets ask how the Fed will react to incoming information. A significant reduction in Fed transparency could make financial conditions—and thus economic outcomes—more volatile as market assumptions about the Fed’s thinking become subject to fewer reality checks.
Takeaways by Macro Roundup® AI
Half of the 18 FOMC participants submitting interest rate projections penciled in one or more rate hikes for the remainder of 2026, and the median core PCE inflation projection for 2027Q4 rose to 2.5%.
The baseline forecast remains for no rate hikes, with hikes judged less likely than markets are pricing despite upside risks raised by the first FOMC meeting under Chairman Warsh.
Warsh said financial markets perform best when they react to incoming data, though a significant reduction in Fed transparency could make financial conditions and economic outcomes more volatile.
Related Articles:
Home Alone: Inflation And The New Fed Chair— Current readings on labor market tightness, manufacturing price pressures, supply chain tightness and the output gap resemble conditions that have historically preceded Federal Reserve rate increases rather than cuts, and futures markets are pricing in hikes. Averaging several monetary policy rules implies a policy rate of 4.00%–4.85% versus the current 3.50%–3.75%.
US Daily: June FOMC Recap: Hikes Look More Likely but Are Still Not Our Base Case— Nine Federal Reserve policymakers projected an interest-rate increase in 2026 and the median projection for core inflation in 2027 rose to 2.5%, a hawkish surprise that lifted market pricing for the end-2026 policy rate by 0.2 percentage points. The authors still expect the Federal Reserve to leave its policy rate unchanged this year.
The Case for Higher U.S. Rates— Underlying U.S. inflation continues to run faster than the Federal Reserve's target and may be accelerating slightly, while growth, consumer spending, and a healthy job market keep wages rising about 1 percentage point faster than in the years just before the pandemic. On that evidence, the author argues rate increases, not cuts, are the appropriate policy.
AI Summary.Nine Federal Reserve policymakers projected an interest-rate increase in 2026 and the median projection for core inflation in 2027 rose to 2.5%, a hawkish surprise that lifted market pricing for the end-2026 policy rate by 0.2 percentage points. The authors still expect the Federal Reserve to leave its policy rate unchanged this year.
David MericleGoldman Sachs
Date Posted:
While market pricing for FFR hikes by the end of 2026 increased, Goldman’s “base case is still that the FOMC will leave the policy rate unchanged this year.”
Do hawkish central bank projections signal a rate hike this year?
Core argument: Nine FOMC participants projected a rate hike in 2026 at the June meeting, versus Goldman Sachs' expectation of three, and the median 2027 Q4/Q4 core PCE inflation projection rose to 2.5% against an expected 2.3%.
The June FOMC meeting delivered a hawkish surprise, with nine participants projecting a hike in 2026 (vs. our expectation of three) and the median projection for 2027 Q4/Q4 core PCE inflation rising to 2.5% (vs. our expectation of 2.3%). Market pricing for the fed funds rate at the end of 2026 rose by 20bp in response to the projections and Chairman Kevin Warsh’s press conference. The FOMC meeting raises the risk of interest rate hikes later this year, but our base case is still that the FOMC will leave the policy rate unchanged this year. A majority could support a hike, perhaps for a range of different reasons, if upcoming inflation prints are uncomfortable and job growth remains solid. But we suspect that most of the voters still lean toward an unchanged policy rate and that participants treated the news about a deal with Iran and the reopening of the Strait of Hormuz cautiously for now.
Takeaways by Macro Roundup® AI
Nine FOMC participants projected a rate hike in 2026 at the June meeting, versus Goldman Sachs' expectation of three, and the median 2027 Q4/Q4 core PCE inflation projection rose to 2.5% against an expected 2.3%.
Market pricing for the fed funds rate at the end of 2026 rose 20bp following the June projections and Chairman Kevin Warsh's press conference.
Goldman Sachs' base case remains that the FOMC leaves the policy rate unchanged this year, though a majority could support a hike if upcoming inflation prints are uncomfortable and job growth remains solid.
Related Articles:
The Case for Higher U.S. Rates— Underlying U.S. inflation continues to run faster than the Federal Reserve's target and may be accelerating slightly, while growth, consumer spending, and a healthy job market keep wages rising about 1 percentage point faster than in the years just before the pandemic. On that evidence, the author argues rate increases, not cuts, are the appropriate policy.
Home Alone: Inflation And The New Fed Chair— Current readings on labor market tightness, manufacturing price pressures, supply chain tightness and the output gap resemble conditions that have historically preceded Federal Reserve rate increases rather than cuts, and futures markets are pricing in hikes. Averaging several monetary policy rules implies a policy rate of 4.00%–4.85% versus the current 3.50%–3.75%.
US Workers Lose Buying Power After War Drives Up Prices— Inflation has outstripped wage growth in key private-sector industries including healthcare, finance, and retail for two straight months, largely because of a surge in energy prices driven by the Iran war. Gasoline prices have fallen since an interim US-Iran peace deal but remain nearly $1 a gallon above pre-conflict levels.
AI Summary.The authors estimate that surprises in US monetary policy spill over into exchange rates, with dollar-denominated reserves substantially mitigating depreciation pressures while non-dollar and gold reserves are associated with smaller effects. Aggregate reserve size alone does not capture external resilience; currency composition and access to dollar liquidity facilities are empirically relevant.
Joshua Aizenman, Jamel Saadaoui, Gazi Salah Uddin and Naoki YagoNational Bureau of Economic Research
Date Posted:
When US dollar interest rates rise, currencies fall less if countries have a Fed swap line, substantial dollar FX reserves, or, to a lesser extent, gold. Sanctions and dollar access risk are pushing some reserve managers towards gold.
Does reserve currency composition determine how exchange rates absorb US monetary shocks?
Core argument: Using high-frequency exchange rate data and reserve currency composition for 18 countries, the authors find US monetary policy surprises spill over to exchange rates through dollar liquidity and capital flow channels.
This paper shows that US monetary policy surprises exert significant spillover effects on exchange rate through dollar liquidity and capital flow channels. Using high-frequency exchange rate data and detailed currency composition of reserves for 18 countries, we show that estimated reserve-buffer effects depend on their composition. Dollar-denominated reserves substantially mitigate depreciation pressures, while non-dollar reserves have smaller estimated effects. Gold reserves are also associated with smaller exchange-rate responses, though less strongly than liquid FX holdings due to differences in immediacy and usability. Our results highlight an empirical complementarity between reserve holdings and access to international liquidity facilities such as central bank swap and repo lines. These arrangements are associated with a smaller role for reserve depletion during periods of dollar funding stress. Aggregate reserve size alone does not capture all dimensions associated with external resilience; currency composition and access to dollar liquidity facilities are empirically relevant for exchange-rate responses to US monetary shocks. These findings are consistent with recent large-scale purchases and sales of gold reserves by emerging economies amid sanctions-related restrictions and geopolitical concerns about access to dollar liquidity.
Takeaways by Macro Roundup® AI
Using high-frequency exchange rate data and reserve currency composition for 18 countries, the authors find US monetary policy surprises spill over to exchange rates through dollar liquidity and capital flow channels.
Dollar-denominated reserves substantially mitigate depreciation pressures while non-dollar reserves show smaller estimated effects, and gold reserves are associated with smaller exchange-rate responses than liquid foreign exchange holdings, reflecting differences in immediacy and usability.
The authors find access to central bank swap and repo lines empirically complements reserve holdings and is associated with a smaller role for reserve depletion during periods of dollar funding stress.
Related Articles:
The Boost From the Hard Assets Rotation— Analysts estimate that each 1bp increase in gold's share of US financial portfolios, driven by incremental purchases, raises gold prices by 1.5%, and with gold exchange-traded fund allocations at only about 0.2% of US private sector financial portfolios, further diversification is the main upside risk to a $5,400 gold price forecast.
Global Debt Report 2026— Gross central government borrowing across OECD countries rose 7% to a record $17tn, about 23% of GDP, and is projected to reach roughly $18tn, or 24% of GDP. The United States and Japan account for close to 80% of the area's refinancing requirements, with the US share rising from 57% to 70%.
Gold Overtakes Euro as Global Reserve Asset, ECB Says— Gold has overtaken the euro as a global reserve asset, with central bank gold holdings reaching 36,000 tons, near the mid-1960s peak of 38,000 tons, helped by a 30% rise in the gold price. The European Central Bank finds countries geopolitically close to China and Russia accumulated gold more than others.
AI Summary.The authors present descriptive evidence that global supply chain disruptions were associated with elevated transportation costs, goods supply-demand imbalances, and a surge in goods prices, steepening the aggregate supply curve. In the disrupted state, a contractionary monetary policy shock produces muted responses in real output and spare capacity but a substantially stronger decline in goods prices.
Xiwen Bai, Jesús Fernández-Villaverde, Yiliang Li and Francesco ZanettiNational Bureau of Economic Research
Date Posted:
Bai, et al present evidence that btw 2017 and 2023, monetary tightening reduced US inflation relatively more than output during periods of global supply chain disruption, compared to undisrupted periods.
Does monetary tightening lower prices more when supply chains are disrupted?
Core argument: Using linear projections, the authors find that a contractionary monetary policy shock in the disrupted global supply chain regime produces muted responses in real GDP and spare capacity but a substantially stronger decline in PCE goods prices, especially shortly after impact.
We highlight important interrelated facts connecting global supply chain disruptions to domestic conditions in the U.S. between 2017 and 2023, showing that such disruptions were associated with elevated transportation costs, severe imbalances in the supply and demand for goods, and a surge in goods prices. Supply chain disruptions, which curtail the availability of goods in retail markets, increase the convexity of the aggregate supply curve [i.e. the curve steepens more sharply at higher hypothetical output levels]. As a result, adjustments in demand driven by monetary policy during disruptions lead to significant price changes with limited effects on real output. Next, we employ linear projections (LPs) to identify [the effects of] a contractionary monetary policy shock conditional on the state of the global supply chain. In the disrupted regime, a contractionary monetary policy shock generates muted responses in real GDP and spare capacity relative to the undisrupted regime, but a substantially stronger decline in PCE goods prices, especially in the short run following impact. [Given econometric limitations], we view the analysis not as a definitive assessment, but as descriptive evidence that the data are consistent with the mechanisms highlighted in our theoretical model.
Takeaways by Macro Roundup® AI
Using linear projections, the authors find that a contractionary monetary policy shock in the disrupted global supply chain regime produces muted responses in real GDP and spare capacity but a substantially stronger decline in PCE goods prices, especially shortly after impact.
The authors argue that supply chain disruptions curtail retail goods availability and increase the convexity of the aggregate supply curve, so monetary-policy-driven demand adjustments during disruptions move prices significantly with limited effects on real output.
Global supply chain disruptions between 2017 and 2023 were associated with elevated transportation costs, severe imbalances in the supply and demand for goods, and a surge in goods prices in the U.S., which the authors present as descriptive evidence rather than a definitive assessment.
Related Articles:
How Have Swings in Demand Affected Global Supply Chain Pressures?— The Federal Reserve Bank of New York's Global Supply Chain Pressure Index isolates supply-side disruptions, while an auxiliary "Net" version captures stress from both supply and demand forces. A mix of supply and demand factors is driving an easing of net global supply chain pressure.
Revisiting the Phillips and Beveridge Curves: Insights from the 2020s Inflation Surge— The authors identify a "Beveridge threshold" level of labor market tightness—the ratio of job vacancies to unemployed workers—below which the relationship between inflation and economic activity steepens and labor market adjustment occurs mainly through vacancies rather than unemployment. They estimate that during the post-pandemic inflation surge the unemployment rate fell as much as 1.08 percentage points below this threshold.
AI Summary.The 1951 Federal Reserve–Treasury Accord reestablished central bank independence by granting the Federal Reserve the right to buy government bonds only when it judged prudent and to let long-term interest rates float upward. The author argues the Treasury should control the debt's maturity structure, with the Federal Reserve confining purchases to short-term bonds or lending against collateral.
John CochraneThe Grumpy Economist
Date Posted:
Noting that the 1951 Accord gave the Fed the right not to buy debt, Cochrane proposes a new Accord – which he believes is consonant with Warsh’s views – under which the Fed determines short rates, while the Treasury alone manages the maturity structure.
Should the Treasury, not the Fed, control debt maturity structure?
Core argument: The 1951 Fed-Treasury Accord reestablished Fed independence by giving the Fed the right to buy bonds only when it judged prudent and to let long-term interest rates float upward.
The first Fed-Treasury Accord in 1951 reestablished Fed independence. In the Accord, the Fed won the right to buy bonds only when it thought prudent, and to allow long-term interest rates to float upward. That background is important. A lot of commentary [predicts that] Warsh [will be] Treasury Secretary Bessent’s puppet at the Fed, setting the Fed up to finance deficits without complaint. I think this is exactly the opposite of what is likely to transpire. Warsh has spent over a decade saying that the Fed needs to buy less government bonds, shrink its footprint on markets, let long-term interest rates go where they want to go, and do less overall. The invocation of the Accord, in which the Fed won the right not to buy bonds tells you what’s up. Otherwise, it would be “repeal the accord.” Someone needs to be in charge of the overall maturity structure and its risk-reward consequences for the taxpayer. In my view, this is a job for the Treasury. If the Fed wants to buy lots of Treasury debt in order to provide lots of bank reserves, then the Fed should buy only short-term bonds, or issue reserves via collateralized lending as the ECB does, without buying Treasury debt. If the Fed needs to buy long term debt temporarily for “market function” reasons, then it needs to swap out the interest rate risk with the Treasury, or exchange that promptly for short-term debt.
Takeaways by Macro Roundup® AI
The 1951 Fed-Treasury Accord reestablished Fed independence by giving the Fed the right to buy bonds only when it judged prudent and to let long-term interest rates float upward.
Contrary to commentary predicting Kevin Warsh would act as Treasury Secretary Bessent's puppet and finance deficits without complaint, Warsh has spent over a decade arguing the Fed should buy fewer government bonds, shrink its market footprint, and do less overall.
The Treasury, rather than the Fed, should manage the overall maturity structure and its risk-reward consequences for taxpayers, with the Fed buying only short-term bonds or issuing reserves via collateralized lending as the ECB does.
Related Articles:
Warsh Call for Fed-Treasury Accord Stirs Debate in $30 Trillion Bond Market— A nominee to lead the Federal Reserve has backed a new version of a 1951 Treasury-Federal Reserve agreement that would spell out the size of the central bank's balance sheet alongside the Treasury's debt-issuance plans. Analysts argue such a public pact could tie monetary operations to government deficits and resemble a framework for controlling bond yields.
Convenience Lost— The authors find that fiscal expansion and the resulting rise in Treasury supply pushed convenience yields to zero on short-term Treasurys and below zero on long-term ones, reducing the revenue the U.S. earns from issuing safe, liquid assets. They argue shortening the debt's maturity structure cannot fully offset this, and that international investors may turn to alternative long-term safe assets.
Fiscal Dominance and the Return of Zero-Interest Bank Reserve Requirements— Fiscal dominance requires governments to fund deficits at the margin with non-interest-bearing debt, and the revenue from inflation taxation—both expected and unexpected—is limited. The authors argue a US fiscal dominance episode could end the payment of interest on bank reserves and restore requirements that banks hold large zero-interest reserves against deposits.
AI Summary.A monetarist critique of the Federal Reserve attributes inflation in part to the expansion of its balance sheet and argues that a smaller balance sheet would create room for interest-rate cuts. The same view holds that a large balance sheet encroaches on fiscal policy and carries distributional consequences, implying a trade of wealth effects for lower rates.
Joseph WangFed Guy Blog
Date Posted:
Kevin Warsh, Trump’s nominee for Fed chair, is a long-time critic of the Fed, but from a hawkish monetarist stance. His emphasis on balance sheet reduction may permit him to lower the funds rate more than in the absence of such “quantitative tightening.”
Would a smaller central bank balance sheet allow lower interest rates?
Core argument: Kevin Warsh, a long-time Fed critic, attributes inflation in part to the Fed's balance sheet expansion and argues that shrinking the balance sheet would give the Fed more room to cut interest rates.
Warsh is a long time critic of the Fed who has consistently argued for a smaller balance sheet. He holds a monetarist view where he attributes inflation in part due to the Fed’s balance sheet expansion, so he suggests a smaller balance sheet would give the Fed more room to cut rates. He has also highlighted concerns over mission creep, where a large balance sheet encroaches upon fiscal policy. Secretary Bessent notably echoed the same philosophy in a widely read essay published in Spring 2025 that also expressed concerns over the distributional consequences of a large Fed balance sheet. A Warsh Fed would be one who seeks to trade the wealth effect for more rate cuts.
Takeaways by Macro Roundup® AI
Kevin Warsh, a long-time Fed critic, attributes inflation in part to the Fed's balance sheet expansion and argues that shrinking the balance sheet would give the Fed more room to cut interest rates.
Warsh argues that a large Fed balance sheet creates mission creep by encroaching on fiscal policy, a concern Secretary Bessent echoed in an essay published in Spring 2025.
A Warsh-led Fed would seek to trade the wealth effect for more rate cuts, and Bessent's essay also raised concerns over the distributional consequences of a large Fed balance sheet.
Related Articles:
Data Update 3: The Trust Deficit – Bonds, Currencies, Gold and Bitcoin in 2025!— Federal Reserve rate changes affect short-term Treasuries, but long-term Treasury yields are driven more by expected inflation and real growth, according to the author's analysis. An "intrinsic" 10-year risk-free rate, calculated by adding actual inflation and real GDP growth, tracks the big historical moves in Treasury rates, standing at 5.10% against a 4.18% 10-year Treasury yield.
Who Buys Treasuries When the Fed Reduces its Holdings— Analysis of Federal Reserve balance sheet reduction finds that households and broker-dealers absorbed the additional supply of Treasury securities during the 2017–2019 episode, with household holdings correlated with hedge fund holdings. In the first year of the reduction begun in 2022, households purchased a large share while hedge funds did not, and insurance companies and foreign investors also increased holdings.
Summers Says Slowing Balance-Sheet Runoff Pace Is ‘Alarming’ Signal on Debt Fragility— The Federal Reserve cut the monthly cap on Treasury securities allowed to roll off its balance sheet to $5bn from $25bn; because its purchases create interest-bearing bank reserves, slowing the runoff shortens the effective maturity of US public-sector debt. One argument holds this signals fragility in placing government debt amid worsening fiscal policy.
