Markets are buzzing about whether the Federal Reserve’s rate-cutting cycle will begin in earnest this week or at the Fed meeting in September or November. Few economic decisions are of such misplaced importance.
The Fed has already cut rates, in effect, from its official policy stance of 5.375%. That’s what the Fed’s communications strategy was designed to accomplish. Chairman Jerome Powell has promised substantial rate cuts in 2024 since late last year. And the U.S. stock market has subsequently increased in value by $12 trillion…
The Fed’s other monetary-policy tool—asset purchases—is conspicuously absent from the public discussion. It works differently from the conventional interest-rate tool. The Fed’s giant, unwieldy financial holdings amount to about $7.3 trillion. That’s where the real money is found.
When I joined the Fed in 2006, the central bank’s assets were about $800 billion, representing around 6% of gross domestic product. The Fed was an important government institution, but the scale of its operations was limited and the scope of its responsibility circumscribed. It did its best work without applause and without the audience at the edge of its seats. The Treasury Department was on the front lines of policymaking, debt funding and bill paying. Congress decided the level and allocation of spending.
The 2008 financial meltdown and the 2020 pandemic caused a fundamental, persistent and I fear permanent change. When the crises hit, the Fed expanded its power and influence mightily. Interest rates were rightfully cut to zero to lessen the economic hit. But more economic support was required. At the height of the 2008 shock, the Fed created a new monetary-policy instrument, quantitative easing, to cushion the economy and restart financial markets. The Fed bought hundreds of billions of Treasurys and mortgages on the open market for years.
When the pandemic struck a decade later, the central bank went even bigger and bolder, buying trillions of new assets, including risky private corporate bonds whose acquisition had never previously been countenanced…
The Fed, however, has proved a fickle master. At the height of each shock, it promised to unwind its emergency-era policies when the crisis abated. The economy recovered, employment strengthened, and financial markets boomed. But the Fed never quite got around to disposing of most of its added heft. Today, the Fed’s holdings equal about 26% of gross domestic product, an order of magnitude larger than 2008…
Had the Fed recognized the inflation problem sooner, it wouldn’t have been forced to raise rates so high. Had the Fed’s asset holdings stayed smaller or shrunk faster, inflation wouldn’t have risen so high. Hardworking Americans wouldn’t now be suffering the twin indignities of high prices and higher credit costs.
A dollar four years ago can buy less than 80 cents of goods and services today. But a dollar in the stock market is worth about $1.80. Much of Wall Street applauds the Fed’s big balance sheet and monetary dominance in Washington. Households and businesses on Main Street have far less reason for enthusiasm.
Mr. Warsh, a former member of the Federal Reserve Board, is a distinguished visiting fellow in economics at the Hoover Institution.