‘Gain of Function’ Monetary Policy

Please consider The Fed’s ‘Gain of Function’ Monetary Policy by Scott Bessent.

As we saw during the Covid pandemic, lab-created experiments can wreak havoc when they escape their confines. Once released, they can’t easily be put back. The “extraordinary” monetary-policy tools unleashed after the 2008 financial crisis have similarly transformed the Federal Reserve’s policy regime, with unpredictable consequences.

The Fed’s new operating model is effectively a gain-of-function monetary policy experiment. Overuse of nonstandard policies, mission creep and institutional bloat threaten the central bank’s independence. The Fed must change course. Its standard tool kit has become too complex to manage, with uncertain theoretical underpinnings. Simple and measurable tools, aimed at a narrow mandate, are the clearest way to deliver better outcomes and safeguard central-bank independence over time.

One might think that new tools created after 2008 and the centralization of the financial market would have given the Fed greater insight about the economy’s direction. At a minimum, all those gained functions should have allowed the Fed to steer the economy more effectively. That didn’t happen. In 2009, the Fed forecast that real gross domestic product would accelerate to 4% in 2011. Instead, growth slowed to 1.6%. Cumulatively over that period, the Fed’s two-year projections overstated real GDP by more than $1 trillion. Repeated misses demonstrate that the Fed placed too much faith in its own abilities and in expansionary fiscal policy to spur growth.

Successive interventions during and after the financial crisis of 2008 created what amounted to a de facto backstop for asset owners. This harmful cycle concentrated national wealth among those who already owned assets. Within the corporate sector, large firms thrived by locking in cheap debt, while smaller firms reliant on floating-rate loans were squeezed as rates rose. Homeowners saw their property values soar, largely insulated by fixed-rate mortgages. Meanwhile, younger and less affluent households, shut out of ownership and hit hardest by inflation, missed out on appreciation.

By failing to deliver on its inflation mandate, the Fed allowed class and generational disparities to widen. Its pursuit of a wealth effect to stimulate growth backfired. “Unprecedented inequality is clear proof that the wealth effect is all too effective for the wealthy, but an accelerant to economic hardship for everyone else,” financial analyst Karen Petrou wrote in her book “Engine of Inequality” (2021).

At the heart of independence lies credibility and political legitimacy. Both have been jeopardized by the Fed’s expansion beyond its mandate. Heavy intervention has produced severe distributional outcomes, undermined credibility and threatened independence. Looking ahead, the Fed must scale back the distortions it causes in the economy. Unconventional policies such as quantitative easing should be used only in true emergencies, in coordination with the rest of the federal government. There must also be an honest, independent, nonpartisan review of the entire institution, including monetary policy, regulation, communications, staffing and research.

The U.S. faces short- and medium-term economic challenges, along with the long-term consequences of a central bank that has placed its own independence in jeopardy. The Fed’s independence comes from public trust. The central bank must recommit to maintaining the confidence of the American people. To safeguard its future and the stability of the U.S. economy, the Fed must re-establish its credibility as an independent institution focused solely on its statutory mandate of maximum employment, stable prices and moderate long-term interest rates.

Paul Krugman Slams ‘Sleazy’ And ‘Underhanded’ Campaign

Please consider Scott Bessent, Sleazy Smearer by Paul Krugman on his substack site.

Donald Trump did learn something during his 1^st term. He learned never to hire anyone who shows the least shred of integrity. You won’t find anyone like Gary Cohn or General Milley in Trump’s 2^nd administration. Now he knows to only hire people who are corrupt, bigoted, dishonest, or all three.

And Scott Bessent, the Treasury secretary, clearly satisfies Trump II’s requirements. His recent attacks on the Federal Reserve, part of Trump’s campaign to destroy the Fed’s independence, are vile, underhanded and sleazy. In a better world they would lead to his immediate removal as Treasury secretary.

The vileness is right there in the headline and the first sentence. It’s immaterial whether you believe that Covid was caused by a lab leak or by natural viral infection from animals. The point is that Bessent began his article by pandering to the conspiracy-theory right by taking a contentious proposition popular in those parts, presenting it as if it were established fact, and then — in a complete non sequitur — associating that theory with his criticism of the Federal Reserve.

Mish Comment [Note that Krugman starts off with an unrelated attack on Trump, not what Bessent said. The first nine paragraphs of Krugman’s rant are ad hominem attacks or attempts to change the subject. They have nothing to do with anything Bessent said.]

So how does Bessent deal with the fact that the critics of quantitative easing were proved completely, decisively wrong? By pretending that the evils they wrongly predicted actually came to pass. Younger and less affluent households, he writes, were “hit hardest by inflation.” What inflation? Inflation didn’t spike until 2021-2022, and that was caused by Covid-induced supply bottlenecks. Bessent is clearly trying to rewrite history to smear the Fed.

The main threat to that credibility comes from Trump and his minions, Bessent being the most visible, who are trying to destroy the Fed’s independence.

Finally, this hit piece by Bessent shows why he is so valuable to Trump. In my opinion, unlike virtually all other Trump cabinet members, Bessent isn’t a fool. He’s highly intelligent and well-versed in his area of operation. He understands financial markets. Hence the fact that he willingly smears the Fed by invoking conspiracy-laden tropes and re-writing facts is a window into his character, showing that he isn’t, and never was, worthy of Americans’ trust.

Maybe we should be thankful that he is no longer in the running for Fed Chair.

Ivory Tower Economists

Krugman is an ivory tower economist who would not see inflation if it jumped up and spit grapefruit juice in his eye.

Krugman ignores home prices as if they don’t matter. Not only were home prices going out of sight, they accelerated after after the Fed’s QE madness extended during covid.

Home prices are not in the CPI. Nor are property taxes. Nor is homeowners insurance. So yeah, strip all of that out as if only consumer inflation matters and you get jackass policy from the Fed coupled with jackass comments from clueless economists.

Krugman never addressed any of Bessent’s key points such as ” This harmful cycle concentrated national wealth among those who already owned assets. Within the corporate sector, large firms thrived by locking in cheap debt, while smaller firms reliant on floating-rate loans were squeezed as rates rose. “

How can anyone deny that? Nor can anyone realistically deny the Fed’s alphabet soup of tactics to bail out corporations at taxpayer expense.

Does Krugman deny inept Fed policy created a housing mess of high prices and people trapped in their homes?

He cleverly does not say. Instead, he posts asinine charts of purported inflation and also inflation expectations.

Krugman is not bright enough to know the Fed’s own studies (and common sense) show inflation expectations are irrelevant.

Bessent’s Criticisms of Quantitative Easing

• Contributes to wealth inequality: Bessent argues that QE primarily benefits the wealthy by inflating asset prices, while hurting less affluent households who are hit hardest by subsequent inflation.
• Distorts markets: He contends that the Fed’s bond-buying programs interfere with the free market by artificially driving down long-term interest rates and effectively picking winners and losers in the economy.
• Undermines Fed credibility: Bessent claims that the Fed’s actions, including QE, have clouded its mission, politicized its actions, and damaged its credibility with the public.

Economist Paul Krugman accuses Bessent of misrepresenting the facts by suggesting the Fed’s post-2008 QE caused harmful inflation, when in reality inflation remained low until the post-COVID spike. 

I side with Bessent. I thought his piece was well written. And I am certainly not a Trump apologist.

The hit job was by Krugman.

Fedthink! The Fed Is Incompetent by Design

In case you missed it, please see Fedthink! The Fed Is Incompetent by Design and Can’t Be Fixed

We are trapped in “Fedthink”, especially the nonsensical proposition that two percent inflation is a good thing despite the fact that the Fed is clueless on how to measure inflation in the first place.

Is the Fed playing politics? Does the Fed know what it’s doing at all?

Q: Does the PCE count property taxes or insurance?
A: Of course not , silly, for the same ridiculous reasons as the CPI.

Supposedly, only consumer expenses matter and neither property taxes nor insurance are consumer expenses.

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