Joseph Wang: The Fed is the last bastion against political pressure, shrinking its balance sheet will impact risk markets, and Kevin Warsh’s poor monetary policy judgment | Forward Guidance

Key takeaways

• The Federal Reserve is seen as a last stronghold against political pressure on interest rates.
• Shrinking the Fed’s balance sheet may impact risk markets.
• Kevin Warsh’s past monetary policy judgments are viewed critically.
• Warsh’s monetarist views lead him to fear inflation from Fed balance sheet expansions.
• Current labor market conditions and productivity gains are leading to expectations of rate cuts.
• Quantitative easing does not guarantee inflation due to varying money velocity.
• The Fed stopped targeting money supply because it was ineffective.
• QE affects financial asset prices more than the private sector’s purchasing power.
• There’s a distinction between financial inflation and main street inflation, driven by QE.
• The central bank and commercial banks can create credit, impacting liquidity in non-banking sectors.
• Political dynamics influence the Federal Reserve’s independence.
• Monetary policy changes can have significant market stability consequences.
• Warsh’s potential impact on future monetary policy is under scrutiny.

Guest intro

Joseph Wang is the CIO at Monetary Macro and principal of FedGuy.com. He previously served as a senior trader on the Federal Reserve Bank of New York’s Open Markets Desk, where he implemented monetary policy. He is the author of the bestselling book Central Banking 101.

The Federal Reserve’s role against political pressure

• The Federal Reserve is becoming the last stronghold against political pressure regarding interest rates.

  — Joseph Wang

• The president has joked about suing the Fed if rates aren’t cut, highlighting political tensions.
• Understanding the Fed’s independence is crucial for grasping current monetary policy debates.
• Political influence challenges the Fed’s ability to maintain independent monetary policy.
• The Fed’s resistance is seen as vital for maintaining economic stability.

• I kind of get the sense that the federal reserve is kind of the last bastion of the resistance.

  — Joseph Wang

• The Fed’s role is critical in balancing political and economic pressures.
• Central bank independence is a cornerstone of effective monetary policy.

Impact of shrinking the Fed’s balance sheet

• Shrinking the Federal Reserve’s balance sheet will likely impact risk markets.

  — Joseph Wang

• Reducing the balance sheet could lead to increased market volatility.
• Investors need to be aware of potential changes in market dynamics.
• The balance sheet reduction is a key focus for future monetary policy.

• My base case is it’s not easy to shrink this without having an impact on risk markets.

  — Joseph Wang

• Understanding balance sheet policies is crucial for financial market participants.
• The Fed’s actions may have unintended consequences on market stability.
• Market participants should prepare for potential disruptions from policy changes.

Kevin Warsh’s monetary policy views

• Kevin Warsh has consistently exhibited poor judgment on monetary policy.

  — Joseph Wang

• Warsh’s hawkish stance is a key aspect of his economic perspective.
• His past roles provide insight into his potential future policy decisions.
• Warsh’s monetarist view leads him to fear inflation from Fed balance sheet expansions.

• He’s someone who has consistently exhibited not very good judgment on monetary policy.

  — Joseph Wang

• Understanding Warsh’s views is important for assessing his impact on the Fed.
• His nomination could shift the Fed’s policy direction.
• Warsh’s approach may influence future monetary policy debates.

Labor market and productivity’s influence on rate cuts

• The current labor market conditions and productivity boom are leading to expectations of rate cuts.

  — Joseph Wang

• A weak labor market and productivity gains are seen as disinflationary.
• Rate cuts are expected to support economic growth amid these conditions.
• Understanding labor market dynamics is crucial for predicting monetary policy.

• The labor market you know not doing that great and also we have this huge productivity boom.

  — Joseph Wang

• Productivity improvements may allow for more accommodative monetary policy.
• Economic indicators are key to understanding rate cut expectations.
• The Fed’s policy decisions are influenced by labor and productivity data.

The complexities of quantitative easing

• Quantitative easing does not guarantee inflation due to the time-varying nature of money velocity.

  — Joseph Wang

• QE’s effectiveness depends on the velocity of money, not just money supply.
• The Fed’s balance sheet expansion doesn’t directly lead to inflation.
• Understanding QE’s mechanics is crucial for grasping its economic impact.

• The velocity of money was something that was time varying.

  — Joseph Wang

• QE’s effects on inflation are more complex than commonly assumed.
• The relationship between money supply and inflation is not straightforward.
• QE’s role in monetary policy requires careful analysis.

The Fed’s shift away from money supply targeting

• The Federal Reserve discontinued targeting the money supply because it was ineffective.

  — Joseph Wang

• The shift reflects a change in the Fed’s approach to monetary policy.
• Targeting money supply didn’t yield desired economic outcomes.
• Historical policy changes impact current economic understanding.

• The fed also discontinued targeting the money supply because they realized that it doesn’t work.

  — Joseph Wang

• The Fed’s strategies have evolved over time to address economic challenges.
• Understanding past policy shifts is important for current monetary policy analysis.
• The Fed’s focus has shifted to other economic indicators.

QE’s impact on financial asset prices

• Quantitative easing (QE) primarily affects financial asset prices rather than increasing the purchasing power of the private sector.

  — Joseph Wang

• QE changes asset composition, not private sector purchasing power.
• The policy’s impact is more pronounced in financial markets.

• Fed prints a lot of money but you know you don’t really it doesn’t increase the purchasing power of the private sector.

  — Joseph Wang

• Understanding QE’s effects on asset prices is crucial for investors.
• The policy’s role in financial markets is a key focus for the Fed.
• QE’s impact on the real economy is limited compared to financial markets.
• The Fed’s actions influence asset prices more than consumer spending.

Distinction between financial and main street inflation

• There is a distinction between financial inflation and main street inflation, with QE effectively driving financial asset inflation without corresponding main street inflation.

  — Joseph Wang

• QE’s effects are more pronounced in financial markets than in the broader economy.
• Understanding inflation types is crucial for policy discussions.

• There’s this important distinction between… financial inflation and main street inflation.

  — Joseph Wang

• The Fed’s policies have different impacts on various sectors of the economy.
• QE’s role in financial asset inflation is a key consideration for policymakers.
• The distinction influences public understanding of inflation.
• Policy discussions must address the different types of inflation.

Credit creation and liquidity impacts

• The central bank and commercial banking system can create credit out of thin air, impacting liquidity in non-banking sectors.

  — Joseph Wang

• Credit creation by banks influences economic liquidity.
• The mechanism is crucial for understanding monetary policy effects.

• The central bank and the commercial banking system have elastic balance sheets.

  — Joseph Wang

• Banks’ ability to create credit affects liquidity in the economy.
• Understanding credit creation is important for analyzing economic conditions.
• The interaction between banks and the economy is a key focus for the Fed.
• Credit creation’s impact on liquidity is a fundamental economic concept.