Reserve Judgment: How To Run a Central Bank

Summary

Many Happy Returns – "Reserve Judgment: How To Run a Central Bank"
Date: June 3, 2026
Hosts: Ramin Nakisa & Michael Pugh

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Overview

This episode of Many Happy Returns dives deep into the world of central banking, framed around the transition from Jerome Powell to Kevin Warsh as Chair of the U.S. Federal Reserve. The hosts reflect on Powell’s tumultuous tenure, assess the major challenges facing central banks, dissect policy strategies, and ponder the big philosophical questions: What is a central bank for? How independent should it be? And can monetary policy ever avoid controversy?
Listeners get a lively, accessible guide to both recent Fed history and the mechanics and ideology of modern central banking.

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Key Discussion Points & Insights

1. Jerome Powell’s Fed Chairmanship: A Crisis-Era Retrospective

• Powell’s Era Defined by Crisis
  • Oversaw the response to COVID-19, geopolitical shocks (wars, trade wars), and the highest inflation in 40 years.
  • "I really liked him and I think he actually did a lot of good stuff for the Fed. And he had a really difficult time." – Ramin (01:13)
• Aggressive Crisis Response
  • During COVID, the Fed used its unlimited balance sheet: massive Treasury purchases, backstopped corporate and money markets, even bought junk bond ETFs.
  • “It was just breaking new ground every day as each crisis popped up and playing whack-a-mole with all these markets...” – Ramin (02:34)
  • "Not only did he save the US economy, he saved our portfolios." – Ramin (04:00)
• The ‘Money Printer Go Brr’ Moment
  • The meme encapsulated the Fed's aggressive monetary stimulus.
  • "But it's not far off what actually happened, is it really?" – Michael (04:21)
• Communication Style
  • Powell’s “calm approach...very plain spoken.” His pressers were clear, focused on the Fed’s mandate.
  • “He'd always start with the Fed's mandate, where he very clearly laid out that they're there to serve the American people.” – Ramin (04:56)

2. The ‘Transitory’ Inflation Saga & Policy Shortcomings

• Transitory Misstep
  • Powell’s infamous description of inflation as transitory backfired, especially as prices soared with no real deflation afterward.
  • "Inflation spikes are transitory. So in that sense, he was right. What he didn't really capture in that phrase was the huge scale of the inflation spike..." – Ramin (05:32)
• Delayed Rate Hikes
  • Criticism over the Fed’s late action: inflation climbed above 2% in March 2021, but hikes started only in March 2022.
  • "That was far too late. I'd agree with that." – Ramin (09:24)
• International Context
  • The inflation mistake was not just the Fed’s; “it was a global phenomenon, as was the central bank mistake.” – Ramin (10:05)
• Soft Landing Achieved?
  • Despite skepticism, inflation fell without a deep recession – a relative win.
  • “He did manage to engineer a reduction in inflation...We did get a soft landing without crushing the jobs market.” – Ramin (11:17)

3. Powell’s Early Tenure: Hawkish Start and the ‘Powell Pivot’

• Pre-pandemic Policy Whiplash
  • Early rate hikes caused a near-bear market in 2018; then he quickly reversed course in 2019.
  • “He did a huge U-turn... started cutting rates again, despite the fact we weren't in recession.” – Michael (13:50)
• Question of Independence
  • Debate over whether Powell bent to Trump and market pressure.
  • “That Powell pivot...was kind of a weakening of Fed independence.” – Michael (14:11)
  • Ramin argues, “The Fed chair can only do so much.”

4. Fed Independence Under Attack

• Battling White House Pressure
  • Trump regularly attacked Powell personally and professionally.
  • “Having a president describing the Fed chair as a moron... sets a terrible precedent for future presidents.” – Ramin (16:43)
• Powell’s Dignified Response
  • Chose restraint: “I think he played that perfectly...It would have been much less effective if he'd have fired back on social media.” – Ramin (17:13)
• Judicial Protection
  • Reference to a judge quashing DOJ pressure: “The purpose of that subpoena was to harass and pressure Powell.” (17:31)

5. Kevin Warsh: A New Era?

• Warsh’s Background and Mandate
  • Wealthy, perceived as more hawkish, and perhaps less independent.
  • “There are more questions about whether he's independent or whether he is just going to do whatever Trump wants...” – Ramin (20:19)
• The Balance Sheet Debate
  • Warsh is keen to shrink the Fed’s $6T balance sheet, arguing the emergency expansion must be transitory.
  • “Shrinking the balance sheet is a tightening, however you frame it.” – Ramin (23:07)
• Ample Reserves vs. Scarcity
  • Discussion of ample reserve policy, and how shrinking could destabilize markets.
• Warsh and Data Dependence
  • Sceptical of the current “data dependence” approach:
    • “We should care little about two numbers to the right of the decimal point... evidence of false precision...” – Michael quoting Warsh (25:43)
  • Ramin: “What's the alternative?...Do you depend on models, or...your read of what the economy should do?”

6. The Theory Wars: Disinflation & AI

• AI as a Disinflationary Force
  • Warsh believes AI will fundamentally lower costs and justify less hawkish policy.
  • "Very simply put, Walsh has actually said AI is going to make almost everything cost less.” – Ramin (27:00)
  • Ramin worries: “His prior is very strong, which is worrying.” (27:52)

7. The Future of Fed Communication

• Forward Guidance vs. Secrecy
  • Warsh dislikes "Fed speak" and prefers less transparency, fewer pressers, potentially scrapping the much-loved dot plots.
  • “I don't even really want there to be scheduled meetings... I just think there's too much humanity in what should be objective decisions.” – Michael (32:02)
  • Ramin defends transparency: “Transparency is usually best.” (31:47)
  • Both debate whether markets would fare better with a rules-based 'black box' Fed, ultimately agreeing that human judgment, for all its flaws, is necessary in crises (33:32–34:22).

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Notable Quotes & Memorable Moments

• On the Fed’s Crisis Role:
  • "Not only did he save the US economy, he saved our portfolios." – Ramin (04:00)
• On 'Transitory' Inflation:
  • “Inflation spikes are transitory. So in that sense, he was right. What he didn't really capture...was the huge scale...” – Ramin (05:32)
  • “The characterization of inflation as transitory is probably the worst inflation call in the history of the Federal Reserve.” – Michael quoting Mohamed El-Erian (09:50)
• On Fed Independence:
  • “Powell’s termination cannot come fast enough.” – Michael quoting Trump tweet (16:12)
  • "Having a president describing the Fed chair as a moron or stupid...sets a terrible precedent for future presidents." – Ramin (16:43)
• On Forward Guidance:
  • “I know you think you understand what you thought I said, but I’m not sure you realise that what you heard is not what I meant.” – Ramin quoting Alan Greenspan (29:33)
• On Rules-based Central Banking:
  • "Would you want that to drive the entire US economy? Probably not." – Ramin (32:52)
  • "You don’t want drunk, angry central bankers driving the economic car." – Ramin (34:39)
• On the Real Mandate:
  • "Keep the wheels on the bus, because whatever you call the mandate, that's what they end up doing." – Ramin (37:32)

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Timestamps for Important Segments

• Powell’s Crisis Management: 01:13–04:56
• Inflation & the ‘Transitory’ Mistake: 05:17–10:05
• Flexible Average Inflation Targeting & Late Hikes: 08:06–09:50
• Warsh’s Critique of Data Dependence: 25:43–27:00
• AI as Central Bank Theory: 27:00–27:52
• Debate over Fed Transparency & Forward Guidance: 29:33–32:52
• Rules-based Central Banking & Human Judgment: 32:02–34:22
• Quickfire Round on Central Bank Principles: 36:52–43:44

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Quickfire "Hot Take" Section: Central Banking’s Biggest Questions

Mandate: Dual vs. Single (36:52–38:07)

• Ramin: Mandate should be “keep the wheels on the bus.” Favors crisis flexibility.
• Michael: Prefers dual mandate, but notes trade-offs for democratic legitimacy.

Independence & Democratic Legitimacy (38:07–39:38)

• Neither host thinks full democratic control would work—too much pressure to maintain low rates.

Is 2% Inflation the Right Target? (39:38–41:38)

• Ramin: Slightly higher target (2–3%) might be better. Some inflation encourages spending.
• Average targeting isn't practical after big spikes.

Transparency vs. Poker Face (41:38–42:30)

• Ramin: Likes “dot plots” and transparency; Bank of England should adopt.
• Michael: Would prefer even more detailed member transparency.

Should the Fed Lean Against Asset Bubbles? (42:30–43:36)

• Both: Yes, intervention should be symmetric—pop bubbles if you’re going to cushion crashes.

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Concluding Thoughts

• Powell’s tenure largely a success by crisis-era standards, despite serious challenges and criticisms.
• The incoming Warsh era may bring a less communicative, more hawkish, and possibly less independent Fed—but institutional inertia and economic reality set limits.
• The hosts highlight the ever-present tension between technical expertise, public accountability, and economic reality in central banking—leaving the door open to both skepticism and optimism.

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For more information, listener Q&A, or to sign up for Ramin’s market newsletter:
Visit pensioncraft.com or email [e-mail]

Transcript

[Romin Nikiza]

Today's episode is sponsored by Trading 212 the platform bringing commission free investing to everyone. The Powell era is over. A pandemic, two wars and the worst inflation in four decades. We ask whether J. Powell did a good job or just survived it. Now Kevin Walsh inherits the chair. But what actually changes?

[Michael Pugh]

Beneath the handover lie bigger questions. What a central bank is really for, who it answers to who, and whether any of it works the way they claim. We give our take on the best way to run monetary policy. All right, let's get into it. So we're here to talk central bankers. We don't vote for them. Most of the public probably couldn't name them. But there are few people with more consequence for our everyday lives. And the most important central bank in the world is, is the Federal Reserve in America. And there's just been a change at the helm of that organization. Now, before we go onto the new Fed chair, Kevin Walsh, let's talk about the man who's just left the hot seat, Jerome Powell. How do you see his eight years in charge?

[Romin Nikiza]

I really liked him and I think he actually did a lot of good stuff for the Fed. And he had a really difficult time. He had a huge crisis with COVID which I thought he dealt with very well. And then he had Trump, which was also a huge crisis I think for the Fed. And again, I think he's handled that very well. Maybe not as Trump, who appointed him would have expected him to, but overall I'd give him very good marks for his tenure.

[Michael Pugh]

It has been an era defined by crisis really, and the biggest one was clearly Covid. Do you think Powell and the Fed effectively saved the economy from a depression back in 2020?

[Romin Nikiza]

I think so. If you compare it with what happened with the global financial crisis, which was the Fed acting very aggressively, but the government not in this case. What happened is the Fed was super aggressive in its response and we can talk about that response in a moment, but it was super aggressive. That went hand in hand with huge stimulus from the government and that turned what could have turned into a huge drag on US gdp, maybe even global gdp, and turned it into something that was fairly short lived. Now we paid a price for that later, but I think the price that we paid is probably better than the alternative. Now, if you did want to read about exactly what went on during this period of crisis and what the Fed did about it, Trillion Dollar Triage, which is actually written by Nick Timrous of the Wall Street Journal, he wrote a really detailed account of what the Fed did during that period and the really unprecedented steps it had to take, it was just breaking new ground every day as each crisis popped up and playing whack a mole with all these markets, which were essentially in free fall and grinding to a halt. And the Fed used its balance sheet in order to buy almost everything.

[Michael Pugh]

Now I was going to say is the response just to buy everything. It doesn't sound that clever, if that's what it is.

[Romin Nikiza]

Yeah, but I mean, what can the Fed do? It's just got an unlimited balance sheet at its disposal. And it used it, and it used it very effectively. So the treasury market was the epicenter. If that freezes up, then it affects pretty much everything. And it bought lots of Treasuries.

[Michael Pugh]

It also bought corporate bonds, even junk bonds, I believe.

[Romin Nikiza]

Yeah, that was via junk bond ETFs. That was really unusual. But money market funds as well, those froze up and the Fed bought what it needed to in order to get that market moving again. Commercial paper, almost everything essentially went into free fall.

[Michael Pugh]

It was just one step removed, I guess, from piling into the equity market itself.

[Romin Nikiza]

And yet the equity market, if you look at the timing of the turnaround after the post Covid crash to the day, it was that massive buying program from the Fed. So not only did he save the US economy, he saved our portfolios. Michael.

[Michael Pugh]

Yeah, I mean, that's where the meme money printer go brr. Comes from.

[Romin Nikiza]

Right?

[Michael Pugh]

That era.

[Romin Nikiza]

I love that meme.

[Michael Pugh]

But it's not far off. What actually happened, is it really?

[Romin Nikiza]

No, it's exactly right. I mean, the Fed can essentially rustle money out of nowhere. It can create money and it used its balance sheet really effectively.

[Michael Pugh]

So you're giving him top marks for what happened in the crisis. And that is when central bankers do need to step up to the table. And it's not just you. People like Warren Buffett and Charlie Munger also said Jerome Powell did an amazing job and they were scared of what was happening in the repo market and the treasury market. And I think Jerome Powell just came across as a safe pair of hands, didn't he?

[Romin Nikiza]

That's true. And he had this calm approach which never faltered. He just is someone that does his job with no fuss and is very plain spoken. I think his Fed press conferences were very clear. He'd always start with the Fed's mandate, where he very clearly laid out that they're there to serve the American people.

[Michael Pugh]

But. And there has to be a but. When we're reviewing anyone's tenure, no one gets Everything. Right. I think it's fair to say he made a pretty big mistake in using the word transitory to describe the post pandemic inflationary surge we saw.

[Romin Nikiza]

Yeah, he got a lot of stick for the word transitory, and he had to backpedal on the actual use of the word when he was giving testimony to Congress later on. Now, trivially, inflation spikes are transitory. So in that sense, he was right. What he didn't really capture in that phrase was the huge scale of the inflation spike that we got. And I think a lot of people learned on the fly that inflation doesn't backpedal. You don't get a period of deflation to compensate for those higher prices. And we always anchor on where we were, say, two years ago or even longer. So the cumulative inflation has been crushing for many US Families, particularly the poorer ones.

[Michael Pugh]

I think overall prices are around 30% higher almost than they were before the pandemic, which is a huge jump in five or six years.

[Romin Nikiza]

That's right. And I think the Fed, really, their job is to deal with these huge crises, but also to deal with a huge inflation that can follow arguably as a result of their response. So in a sense, they created the problem, which they then have to fix, but it avoided another problem. I mean, we'll never see a world in which the Fed didn't act aggressively, but if it hadn't, I think it would have been worse. Very difficult to call, I think. But if it could have massively raised interest rates, a kind of volcker like, huge surge in rates following the huge cut. The question is, would that have lost the Fed's credibility? Because you could say, look, you're just reeling from one thing to the next. You're now trying to stop the problem

[Michael Pugh]

you created and stopping it by crushing

[Romin Nikiza]

the economy, which wouldn't have played very well with the average person in the street. It's very difficult to take the punch bowl away. And I think that shows the limitations of what a central bank can do in a way.

[Michael Pugh]

But don't you think it's a little weird that we're saying Jerome Powell did a good job when inflation has run very hot in his tenure and it's never returned back to the 2% target since early 2021. Now we might be saying, well, that was inevitable. He couldn't have brought it back down any faster. But I think his critics would say the Fed was late to hike rates. It was too complacent, it was too focused maybe on the jobs market and maximum employment, which is the other half of its mandate and had taken its eye off the ball on inflation because inflation had been so low in the post financial crisis era.

[Romin Nikiza]

Yeah, because it's hard to remember now, but if you cast your mind back just before we got the huge Covid crash and all the other stuff that followed, inflation had been running too cool. And the Fed was actually struggling to keep inflation at its 2% target. And so it introduced this new scheme which is called fait, which stands for flexible average inflation targeting. It's a very simple idea. If we run below the average, you let it run a bit hot afterwards, so that over a long period of time, it averages out at the Fed's target of 2%. And if it runs hot, you let it run cool for a while afterwards.

[Michael Pugh]

So they came up with this new regime, this flexible inflation targeting idea in the early stages of the pandemic. Actually, after a long period of cool inflation and into a shock where, at least in the early stages, the economy was weakening and there didn't look to be a lot of inflationary pressure, they said, okay, after we get out of this, we'll run inflation hot. But I don't think they meant double digits hot. And it was sort of quietly shelved as an idea after the pandemic because I think it would have meant you'd have to crush inflation right back down for a long time, possibly into recessionary territory to get that average 2% over the medium term.

[Romin Nikiza]

It was an awful idea, I think. And if you look at the timeline, it's really clear that maybe that's the reason why they let it run a bit hot for too long. So inflation moved above 2% in March of 2021 post Covid and then it hit 6.2 by October and then it peaked at 9.1 in June of 22. Now the Fed didn't start hiking until March of 2022, so that was far too late. I'd agree with that.

[Michael Pugh]

Mohamed El Erian, who's one of the most prominent commentators, I guess, on monetary policy, he said the characterization of inflation as transitory is probably the worst inflation call in the history of the Federal Reserve.

[Romin Nikiza]

But if you look at central banks elsewhere, I think that's true of a lot of central banks, which is that they've just seen this huge Covid switch off the economy reaction. They thought that it was important to get the economy moving again. And if inflation was one of the results of that, I think people are willing to live with some inflation. But look at inflation across the developed world, em, and it's not something that's specific to the US it was a global phenomenon, as was the central bank mistake, which is not to massively increase rates after the inflation spike really started to move up in earnest.

[Michael Pugh]

In retrospect, we were always going to get an inflation spike, weren't we, because of what happened to supply chains and then the energy crisis. But it probably didn't have to be as bad as it got. And the second order effects possibly could have been mitigated had the Fed come out of the blocks earlier. But despite everything, would you say Powell managed to engineer a soft landing? We got through it all and inflation came down, albeit not quite to target without a recession. And most people thought that wasn't going to happen.

[Romin Nikiza]

People thought it was impossible. You just read the commentary and you can see it going from complete disbelief about a soft landing all the way through to oh, actually, yes, it was a soft landing, but hardly anyone talked about it. So I think that's another victory for Powell, which is that he did manage to engineer a reduction in inflation. Maybe they weren't responsible for it. I mean, there's a question of whether monetary policy was what guided us back down or whether it was just a reaction to supply chains improving and behavior normalizing for humans around the planet. But whatever you think, that's what happened. We did get a soft landing without crushing the jobs market, despite a period of very high interest rates relative to where we'd been, of course. And that's never discussed, which I think is quite odd.

[Michael Pugh]

I think it's because they didn't quite stick the landing. If they had a 2% print at some time, they could have really sort of flown the flags and gone, we did it, mission accomplished. But then we got the trade war just before we got back to 2%.

[Romin Nikiza]

This is it. So I think the Fed can only do so much. And if the government is doing things like trade wars, which are inflationary, there's very little they can do in order to counteract that. It just makes their job that much harder.

[Michael Pugh]

Powell does seem to have had a fair chairmanship which has rolled from crisis to crisis and not his crises. Right. He didn't release Covid into the wild, he didn't invade Ukraine, he didn't start a trade war. His job was just to sort of manage these things and stop the economy falling off a cliff. But maybe we've scooted over the very early part of his reign, the pre pandemic era, which I think if you were looking for something where he genuinely didn't do a great job would probably be this. He entered office really as a hawk, and during 2018 was hiking rates up and was saying things like, we're a long way from the neutral rate. He was shrinking the balance sheet on autopilot, as he said, and the market freaked out a bit. We almost entered a bear market in the S&P 500. It was almost down 20% by Christmas in 2018. And then he did a huge U turn at the start of 2019 and started using words like patient and flexible and started cutting rates again, despite the fact we weren't in recession. That sort of whipsaw in policy outside of a crisis is kind of forgotten about now, but is maybe more of a black mark on his record.

[Romin Nikiza]

But look, when he moved into the Fed job, he'd taken over from Yellen and he'd taken over mid hike. Right. So they were in a hiking cycle. So what he could have done was aggressively start cutting. Look, a Fed appointee by Trump, radically cutting after Yellen had been hiking. That would have been quite difficult, I think, optically.

[Michael Pugh]

But that Powell pivot in 2019, the cynical view was that that was kind of a weakening of Fed independence because he was doing what the White House was explicitly calling for. Trump was out there shouting for rate cuts, and Powell was kind of bullied into it by a combination of Trump and the stock market. The Fed put was, you know, live and kicking at that stage.

[Romin Nikiza]

Yeah, it's interesting. I think when he first started, he was probably quite keen to show that he was independent. Perhaps that's why he was hiking at that time. But remember that it isn't just his decision about whether to hike or to cut. So the committee. There would have been continuity from Yellen to Powell. They were still thinking the same way. The economic data that they were seeing was what was driving their decision. So I wouldn't overestimate Powell's effect on what happened to the rate decisions. The Fed chair can only do so much.

[Michael Pugh]

Yeah, but I'm not going to give him credit when things go well and just say it was the committee's fault when things don't go so well. And yeah, if you're being generous, you can just say the data changed, so the Fed changed. I don't quite buy it, unless you're counting the stock market as a key data point.

[Romin Nikiza]

But I think that's one of the things which he did push, which is the idea that you don't depend on models which look forward because they're just very unpredictable and very poor. Look at the data as it is right now. That was one of his big things, certainly in his communications at the press conferences.

[Michael Pugh]

I think the history books, when they look back at Powell's term, obviously they'll focus on these economic crises he's had to weather. But the thing that might really stand the test of time is that there's been open warfare, really, between the White House and the Federal Reserve. This idea of Fed independence has come under question probably more than ever before. China. Do you think he's done a good job of standing up to Trump?

[Romin Nikiza]

Yeah. And the attacks grew ever more forceful. We had it in Trump's first term, starting just after he'd been appointed, with tweets like, I'm not thrilled that the Fed is raising rates. And that led to a Christmas day tweet in 2018, the only problem our economy has is the Fed. And then it became personal in Trump's second term, for example, Powell's termination cannot come fast enough.

[Michael Pugh]

And that was maybe the most polite way he ever talked about Jerome Powell over the last couple of years.

[Romin Nikiza]

Yeah. Having a president describing the Fed chair as a moron or stupid or a numbskull, all of that really eroded the dignity of the presidency in the US And I think it sets a terrible precedent for future presidents.

[Michael Pugh]

Do you think Powell should have fired back with his own insults, or did he do the right thing by just playing everything with a straight bat and never really mentioning Trump by name in press conferences, just saying things like Fed independence is important.

[Romin Nikiza]

I think he played that perfectly. And it would have been much less effective if he'd have fired back on social media. That would have been awful.

[Michael Pugh]

I saw today in the ft, there's a story where Jay Powell warns Federal Reserve is undergoing a stress test like many other US Institutions.

[Romin Nikiza]

He says, but I think that's the way to fight these autocratic governments, which is to say very clearly the facts about what's going on. Which is precisely what he did when he. He published a very short video as Fed chair where he discussed the criminal investigation, which was from the Department of Justice, which was eventually quashed by a US Judge, James Boasberg. And the judge's ruling, I think, says it all. He said that the purpose of that subpoena was to harass and pressure Powell either to yield to the president or to resign and make way for a Fed chair who will.

[Michael Pugh]

Well, he didn't resign, but we have eventually got to the point where we're getting a new Fed chair as Powell's term has ended. And that is Kevin Walsh after the break. Let's discuss what he's going to bring to the role and some of the bigger questions that underpin central banking.

[Romin Nikiza]

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[Michael Pugh]

Okay, so we spent quite a bit of time looking back at Jerome Powell's term as Fed chair. His successor, Kevin Walsh, has taken office now with his confirmation in the Senate going basically along partisan lines. I think only one Democrat voted for him, which is extremely unusual. Is he going to bring something very different to the Fed?

[Romin Nikiza]

He's going to bring a lot of money to the Fed. He's a very rich guy and I think that immediately creates these conflicts of interest. But putting that aside, I think there are more questions about whether he's independent or whether he is just going to do whatever Trump wants, which is primarily cutting rates.

[Michael Pugh]

It's hard to tease out from his comments exactly what he thinks about rates at any given time, because I think as a central banker you can't be too idealistic of always thinking rates should be lower or always thinking they should be higher. The whole point is it depends on what's going on in the economy. But there is one part of central bank policy where I think Kevin Walsh is pretty consistent, and that is that he thinks the Fed's balance sheet should be shrunk right down now just to

[Romin Nikiza]

Explain what happened with the balance sheet if the Fed's buying everything. Well, suddenly all of these assets sit on the asset side of the Fed's balance sheet. So that blew up to about 9 trillion the size of that balance sheet. And then what the Fed did is say, look, we won't buy any more, we'll just let these bonds mature. And the size of the balance sheet shrank as that happened. Now that caused a few hiccups on the way down. But as Walsh takes over, the size of the balance sheet is now 6 trillion. So let me just explain how this is another type of monetary policy, because one we always think about is the interest rate which the central bank sets. The balance sheet is another form of accommodation. It injects cash into the economy. Effectively the Fed has bought those Treasuries and when it bought them, it paid cash and that cash sits with banks and then it ultimately works its way into the economy via lending. So we call this an ample reserve policy.

[Michael Pugh]

Which means what? There's so much money sloshing around the system that banks are not having to compete very hard to get capital.

[Romin Nikiza]

Yeah, we call this excess reserves. So the central bank ensures that there's lots of excess reserves in the banking system, far above the minimum reserve requirements.

[Michael Pugh]

And effectively the amount of cash in the banking system has no impact on short term interest rates when you're in an ample reserve system.

[Romin Nikiza]

And then the Fed has to use this mechanism called the interest on reserve balances to influence short term interest rates. But what that sets is a floor for the Fed funds rate and it gives a way of stabilizing that floor for the lower level of interest rates.

[Michael Pugh]

Okay, it's all getting really technical here. The question around the balance sheet is it's shrunk now from 9 trillion to 6 trillion, more or less. Will Walsh want to continue that fall or accelerate the pace of it? And can he do that without causing a severe market disruption?

[Romin Nikiza]

Well, if you cast your mind back, this happened previously when we didn't have ample reserves. The money market rates shot up very briefly and the Fed had to act in order to stabilize it. Now that might happen under Walsh as well. So he's got to make this transition a smooth one. And that's not going to be easy. Any of these huge shocks to the system as you go from a huge balance sheet to a smaller one, have to be managed very carefully. And if another shock happens on route to that smaller balance sheet, then at least he will have that larger dry powder of a smaller balance sheet so he can start buying assets again. But the actual act of shrinking it may itself destabilize the US economy, which is very much used to a central bank, which is accommodative, because, make no mistake, shrinking the balance sheet is a tightening, however you frame it.

[Michael Pugh]

I think Walsh's view is very much that the massive increase we saw in the size of the Fed's balance sheet must be transitory, to reuse that word. It's a temporary state for an emergency situation, and when we're not in an emergency, it should be shrunk down rapidly, partly to give dry powder to the Fed, partly when things go wrong again, but also because the Fed shouldn't be in the business of kind of guiding rates across the curve by buying Treasuries and electing which ones to buy and which ones to sell. He thinks that's a market function and should be left to private markets.

[Romin Nikiza]

Yeah, that's all very well until things go wrong and then the Fed is left to pick up the pieces. And that happens repeatedly in history. So I'm sure under his tenure that's going to happen again. And. And all of these theoretical ideas melt very quickly in the heat of a crisis, because I think it's pretty clear now that when the treasury market or the government bond market, when the wheels fall off, it's the central bank's job to fix that by buying. It happened in the UK with the trust crisis. It happened in the US when we had these wobbles on repo rates.

[Michael Pugh]

So it seems like there isn't really much disagreement in the central banking community that the Fed's balance sheet should have come down and probably should continue to go down is really a question of how fast you do it and how willing are you to take the risk that something breaks. I agree with you, though. If something breaks, the Fed is going to reverse course very quickly. They're not just going to let money markets explode. But anyway, there's maybe an even more fundamental part of how the Fed works that Walsh has a different view on to Powell, and this is something we mentioned earlier, which is data dependence. Let me give you a quote from Kevin Walsh. I do not find the current Fed policy of data dependence of much real value. We should care little about two numbers to the right of the decimal point in the latest government release, breathlessly awaiting trailing data from stale national accounts is evidence of false precision and analytic complacency.

[Romin Nikiza]

I agree with that. In a way, the data that the Fed gets is out of date, but of course they're aware of that. The question is, what do you replace it with? Is it an opinion about what's going to happen to interest rates? Is it a politically flavored opinion about what's going to happen to the economy? So all I'd say is, what's the alternative? Do you depend on models, or do you just depend on your read of what the economy should do and where it should be, which is also, in a sense, a model?

[Michael Pugh]

I mean, if you think that Walsh and the Fed will become a little less independent and a little more influenced by people in Washington, then maybe they won't need data so much. Maybe the bias will be towards easing unless inflation is going crazy right now.

[Romin Nikiza]

But I think it's also good to look into the mind of Walsh to see what he's been saying about what inflation is caused by. And I think one interesting point of view, which may or may not be right, we'll see, which is that AI is fundamentally disinflationary. In other words, it reduces the rate of inflation. And that's going to be central to the case that the Fed should be less hawkish as Powell leaves and he takes over. So, very simply put, Walsh has actually said AI is going to make almost everything cost less. That's the central idea that could be

[Michael Pugh]

right over the medium term. I guess the question if you're a central banker, is do you wait to see evidence of that before you cut rates because of this disinflationary force, or do you just believe the theory you've come up with and cut rates in advance of that?

[Romin Nikiza]

That's what I'm worried about, that he's going to impose his very strong view, which may or may not be right, rather than focus on what's actually happening in the economy. What we'd say in Bayesian terms is that his prior is very strong, which is worrying.

[Michael Pugh]

Do you not want opinionated central bankers? You want ones that are just a blank canvas? That's not really what I think. I just want the committee to be composed of people from all spectrums and all sides of the argument. And then as the data comes in, some will be able to shout louder, look, I was right. And maybe they can convince other people on the board to vote along with them.

[Romin Nikiza]

I want people who are flexible who will change their opinion based on data. It's fine to have an opinion, but I think you have to be modest in the face of data which opposes that opinion. And having very opinionated people, either for political reasons or because of doctrinal reasons, is going to be a massive problem. For the Fed.

[Michael Pugh]

Ironically, we might be going into a shift in how the Fed views the world at the same time as we're going to learn a lot less about what the Fed thinks. Now, one of Walsh's big problems with how the current Federal Reserve operates is he thinks they're way too chatty. He doesn't like all the Fed speak, all the communication, and he certainly doesn't like the forward guidance and the hints about where rates might go in the future. I think he's even sceptical of things like the dot plots, which I know you love, which show where Fed board members think rates are going. And I don't think he wants so many press conferences.

[Romin Nikiza]

Yeah, my favorite quote from a Fed chair is probably the one from Greenspan. I know you think you understand what you thought I said, but I'm not sure you realise that what you heard is not what I meant.

[Michael Pugh]

Okay, that sums up Fed speak perfectly.

[Romin Nikiza]

Whereas what I think was great about Powell is there was none of that. He was just completely transparent. He talked about the data, the reasons for what they did, and there was no kind of, oh, we're cleverer than you and we're not going to tell you what we're really doing, but here's our decision. You can guess where we came up with it.

[Michael Pugh]

I think there's two things going on here around communication. So what you just mentioned is the kind of transparency and accountability about what you did and why you did it. That seems all well and good. What I think is more controversial was this idea of forward guidance which central bankers have used over the years with things like the dot plots. Although they say don't take it as a forecast, everyone takes it as a forecast. Why should we see what they think might happen? So Kevin Walsh says officials become prisoners of their own words, anchored to stale forecasts, and in a way makes them less flexible. So he thinks we shouldn't do any of that forward guidance business.

[Romin Nikiza]

I read it differently. I think this is little bit like creating a firebreak or maybe even test fires in order to get rid of the kindling so you don't get a massive forest fire when the Fed changes its opinion. If you cast your mind back to huge market reactions to what the Fed's done. This is when we've had turning points where the Fed was saying one thing and then suddenly, because of the data, had to switch to a new thing. If there's more transparency, I think there's less chance of that happening.

[Michael Pugh]

So you kind of forewarn the markets. Look, there might Be a pivot coming.

[Romin Nikiza]

Yeah. And then the response isn't as severe. There isn't a single case, I don't think recently under Powell where the Fed didn't do exactly what the futures market predicted it would. Now that suggests to me that they were communicating and somehow hinting what they were going to do.

[Michael Pugh]

That suggests to me that they wake up and look at the futures market and say, oh, that's where we're going to put rates. Chicken and egg, isn't it?

[Romin Nikiza]

EAS easy, but it is all circular. But given the choice and the fact that markets are going to dissect what the Fed does anyway, I'd say give them more information. In order to do that, transparency is usually best.

[Michael Pugh]

See, my bias for some reason is the other way. I don't want to hear what they think. I wouldn't even care if it was a black box and it just spat out the rate decision every so often. I don't even really want there to be like scheduled meetings. Just tell us when it changes. I don't know, I just think there's too much humanity in what should be objective decisions.

[Romin Nikiza]

Yeah, I mean, that's why they created the Taylor rule. You could just have a machine just churning out policy rates, but that would probably be catastrophic.

[Michael Pugh]

But why?

[Romin Nikiza]

Well, I mean, if you knew what the rule was, you could bet against it. Because if it is deterministic, you could gain the system. Whereas if there's that human element, well, there is a level of uncertainty in what the Fed's going to do.

[Michael Pugh]

Well, you could just build in a random number generator to some element of the rule if that's what you need.

[Romin Nikiza]

Yeah, I guess, I guess. But would you want that to drive the entire US economy? Probably not.

[Michael Pugh]

There are advantages, I think, to having a rule based system. One, it is entirely independent other than who sets the rule. Okay. It also would just remove that temptation to cheat and for central bankers to kind of let their priors influence where policy should be. But I concede this. In extreme situations like the pandemic, it would probably go way off course, would hike rates ridiculously and the economy would suffer. And so you'd have to have a sort of override mechanism which would make the whole thing pointless.

[Romin Nikiza]

Yeah, I mean, look, banks have been doing this for ages. They try to create these automated trading systems. But there's a reason why there are always humans involved, because inevitably they blow up. There are always edge cases where things go wrong and you need humans in order to make those judgments. So that's why I think Automating, this would be a huge problem. Plus there are so many things that feed into the decision. It's not just about the level of inflation. If you've got a dual mandate, there are thousands of pieces of information which feed into that. Then when you get one of these unprecedented periods like Covid, what are the regression coefficients for all that information? It's really difficult to work out a reasonable Taylor rule which incorporates all of that information and deals with all of these edge cases. I think those are the problems.

[Michael Pugh]

To me, it's like the argument around self driving cars. The algorithm doesn't have to be perfect, it would just have to be better than the current system of a dozen central bankers sitting there stroking their beards and hoping to pluck a number out of the air. So I don't know.

[Romin Nikiza]

Yeah, you don't want drunk, angry central bankers driving the economic car.

[Michael Pugh]

Ultimately, I guess we have to accept that central banking is an art, not a science really. And you're never going to get it perfect all the time. One thing I do wonder with Walsh coming in is that I've seen hints and rumours that he might want to cut down the number of policy meetings that happen each year. So at the moment it's eight. Maybe he wants to go to 1.25%. Obviously you'd always keep room for an emergency rate hike or rate cut should you need it, but I think we might see this kind of major structural and procedural review of how the Fed works. He's also talked about greater coordination between the Fed and the treasury around things like the balance sheet, although that does set alarm bells ringing for some people. The word coordination.

[Romin Nikiza]

Yeah, the word puppet springs to mind.

[Michael Pugh]

I don't think he's going to be a puppet.

[Romin Nikiza]

I don't think he could be. I don't think he could do the job. And even if he was, I think the way that the Fed structured it wouldn't be a very effective puppet anyway.

[Michael Pugh]

And if you look at his background, he's worked in central banking for a long time. He's been on the FOMC before. Why would he spend his whole career building up this moment to just come and sort of abdicate his job?

[Romin Nikiza]

Yeah. I think when you walk into that building on day one, there are strong forces to make you behave in the right way. There's an institutional momentum, equality, if you like, of the people who work in the building. And I think he'll probably adjust to that just like Powell did.

[Michael Pugh]

But in summary, we should perhaps expect a Kevin Walsh Fed that talks less Intervenes less, holds fewer meetings, maybe runs a smaller balance sheet and slowly transitions away from a kind of mechanical data dependence.

[Romin Nikiza]

Now it's really important to keep up with what's going on in markets. And a way to do that is look at our weekly market roundup. It's free, it's punchy, it's humorous, and we won't spam your mailbox. To learn more, go to pensioncraft.com Newsletter

[Michael Pugh]

I thought to wrap up Romin, maybe we could do a quick fire hot take section where we look at all the big questions around central banking that people have written PhD theses on and form the basis of treaties. And we'll just give them like a sound by answer with our opinion. Okay, first one for you. The mandate that underpins a central bank. This can vary. So the Fed has a dual mandate. It's targeting stable prices, that is low inflation and also maximum employment. Whereas other central banks like the ECB and the bank of England are only focused on inflation, at least officially. Which do you prefer?

[Romin Nikiza]

I'd call it keep the wheels on the bus, because whatever you call the mandate, that's what they end up doing. So 2% inflation is part of it, but when there's a crisis they'll end up buying stuff. So I'd say keep the wheels on the bus should be their mandate.

[Michael Pugh]

It sounds like a nursery rhyme. I have to say I prefer the Fed's dual mandate. However, there are problems with it, given that it's an unelected body and it necessarily then has to make a trade off which we can't vote on.

[Romin Nikiza]

Yeah, look, if it had to be a choice of what you offered. Yeah, dual mandate is what I'd go for.

[Michael Pugh]

And then it leads us on to the second big question, which is around central bank independence and how that is affected by a sort of democratic legitimacy. We're not voting for these people. And you could say if central bank independence is such a good idea, then why wouldn't you have an independent body that sets taxes too? Which would seem ridiculous. Why is this out of the scope of democracy?

[Romin Nikiza]

I think there's such a strong lobby of people who borrow and want to keep those rates down, property developers for example, but which ultimately could crash the economy and destabilize it. So you have to maintain this balance and in order to do that you have to balance the two different lobbies. So that's why I think it requires some kind of independence to do that.

[Michael Pugh]

I suppose there is a kind of weak democratic accountability in that the people running the central bank are typically chosen by elected officials and they typically come in and answer questions from Parliament or from congressional oversight committees in the US and ultimately a politician could run on the platform that we're going to change how the central bank works. They just haven't run on that platform yet.

[Romin Nikiza]

Yeah, if one of the countries did do that and everything turned out to be absolutely fine, yeah, that would be great. But would that happen? Or would they just fold and say, fine, we'll just set interest rates low? If inflation runs a bit hot, fine.

[Michael Pugh]

Okay, coming on to interest rates, the next big question. Is 2% the right number? It's completely arbitrary and it kind of just came out of New Zealand in the 1990s and everyone said, yeah, sounds good, but that is the official target for all the central banks. Some economists argue for a higher target, 3 or 4%, to give a bit more room on the downside above the zero lower bound, whereas others say 2%. We're going price stability, let's get closer to 0%. Is 2% the right number?

[Romin Nikiza]

I put it a bit higher. And the reason for that is if you look at the price to earnings multiple, the sweet spot is around 3. So you know, maybe 2 or 3% a little bit higher than it is now. The reason why you want some inflation, you might be thinking, why would you ever want inflation? Is that if you don't have some inflation, then people just hoard cash. And that can be a problem for the economy as well and for growth.

[Michael Pugh]

And should that inflation target be a point in time that we're always targeting 2% or 3% or whatever, or should it be average inflation targeting? To go back to what we talked about earlier?

[Romin Nikiza]

Well, we saw the problem with that, which is that if you have these periods of really high inflation, what you end up with is an asymmetric effectiveness of that policy. Because in order to get you back down to an average inflation after one of these spikes, in order to get it back down to the 2%, as you said earlier, you'd need a period of deflation, probably, which would be catastrophic for the economy, or just a long

[Michael Pugh]

period where it's at 1%, if you could engineer that.

[Romin Nikiza]

Yeah, but that's the problem, which is it's difficult to do.

[Michael Pugh]

I suppose the way it actually works in reality, if we're honest, is that they're not really targeting 2%. What they're targeting is, is to be able to publish graphs which show that the line goes back to 2% at the end of the forecast period. Whether that's three or five years and it always does because their models show it goes back to 2%.

[Romin Nikiza]

And you don't want to show that you're incompetent. You'd never want to show that to the market.

[Michael Pugh]

Okay, next question. Transparency or poker face? Would you get rid of the dot plots? Me?

[Romin Nikiza]

No. I like the dot plots. I think the bank of England should have them or something equivalent. In a sense they do already because if you read the minutes now, each of the committee members gives their view about what's going on, which I think is super valuable. So dot or each person's opinion very briefly summarized. I think that's very valuable.

[Michael Pugh]

If you're going to have the dot plot, I would label the dots. It annoys me that they don't. I want to know which member is which dot and how is it changing over time.

[Romin Nikiza]

Yeah, that's why I think the NPC's approach is a good one. You can see that Hugh Pill thinks that, Megan Green thinks that the Governor thinks this. I think that's great. Plus I can make fancy R graphs which are the kind of spectrum of hawkishness versus dovishness, which is great fun.

[Michael Pugh]

Okay. A question which is, I guess relevant at the moment is how do you approach asset bubbles if you're a central bank? Now, we know bubbles are hard to determine in real time. You can just say things look expensive. Maybe, but there's two views, isn't there? One view is that central banks should not care at all about a run up in asset prices. This is just what markets do occasionally. They just have to mop it up when it bursts. And the other view is that when a central bank sees one of these bubbles building up, as it might be in the stock market right now, it should lean against it actively using its tools to slowly deflate it rather than let it pop on its own.

[Romin Nikiza]

I'd go for the latter. I'd go for leaning against the bubbles because again, we've just seen these examples where things get wildly out of control and then we get a huge correction in markets, which is damaging for lots of people.

[Michael Pugh]

Yeah, I think if you're going to have the Fed put, which is when markets crash, the Fed steps in to save them. You should probably also have the opposite of that, which is the when markets go crazy, the Fed steps in to bring them back under control.

[Romin Nikiza]

I agree. I think it has to be symmetric in that way. Otherwise the Fed's just going to amplify these crises.

[Michael Pugh]

Thank you for joining us for many happy returns. Keep sending us your questions, no matter how [e-mail] and do remember to check

[Romin Nikiza]

out pensioncraft.com for all the information about our membership courses and investment coaching options.

[Michael Pugh]

Many Happy Returns is a Pensioncraft production co hosted and executive produced by Romin Nikiza and Michael Pugh. This podcast is for informational and entertainment purposes and is not financial advice. We do not provide recommendations or endorse any decision to buy, sell or hold any security. We cannot be held responsible for any actions listeners may take and investors are encouraged to seek independent financial advice.