Welcome to today’s Morning Jolt. I’m John Puri, filling in for the inimitable Jim Geraghty.
On the menu today: The Federal Reserve is required by law to pursue both maximal employment and stable prices. Yet the institution has demonstrated little interest in the latter part of its mandate. Sure, Fed officials talk about bringing down still-too-high inflation, but they are using none of the tools at their disposal to make it happen. They are more concerned with propping up a stagnant labor market and cleaning up the executive branch’s messes. Beneath all their statements is the unspoken reality that the Fed will likely have to accommodate America’s gargantuan national debt, and may already be doing so. But first, consider this a gentle reminder that we just launched our “Defending America” webathon, so if you’d like to show your appreciation for the work NR does to stick up for this great nation, please contribute any amount.
Read on.
All Talk, No Action
The Federal Open Market Committee, the body within the Federal Reserve that steers monetary policy, met yesterday to vote on the U.S. economy’s benchmark interest rate. This afternoon, Kevin Warsh, the newly appointed chair of the Fed, will announce the committee’s decision. Nothing is certain in this world, but if anything were, Warsh’s announcement would be a certainty: Interest rates will stay where they are.
Warsh is in a bit of a pickle. He was nominated by President Trump on a promise — er, I mean, very genuine conviction — to cut interest rates. Alas, events have been uncooperative. Lower rates are supposed to aid employment, but the labor market has added jobs in each of the last three months, even as it has sputtered these past two years. Inflation, meanwhile, has resurged. As of June, consumer prices have risen 4.2 percent from a year ago. This sizzling pace was driven in large part by higher fuel costs, courtesy of the war in Iran. But “core inflation,” which excludes food and energy prices, ticked up as well. Depending on what metric you prefer, it may be the highest since 2023.
So, the case for cutting interest rates and thereby easing monetary policy has evaporated under Warsh’s feet. He will go in front of the cameras and say conditions have changed, we’re in an unpredictable period, whatever. And that is why the Fed must wait and see how things transpire before cutting rates. For now, it will maintain them.
Here’s the problem: Elevated inflation is not new. The Fed claims that its targeted inflation rate is 2 percent annually, the same as it’s always been. Recorded inflation has been hovering around 3 percent — or 50 percent above the Fed’s stated target — for the past three years. It is on track to be even higher this year. That is a major improvement from 2021 and 2022, when inflation peaked at 9 percent. But imagine that Americans hadn’t seen such startling price hikes during the pandemic. Inflation at 3 or 4 percent would be a scandal for the central bank, one requiring immediate attention. Central bankers would race to tighten monetary policy so that the money supply grew more slowly, returning inflation to normal levels.
In reality, the Fed isn’t doing squat to lower inflation. If anything, its decisions since 2024 have made inflation worse.
The Fed Keeps Making Money
Let’s begin with the basics. Inflation is a general rise in prices across the entire economy, not any particular price increase. Persistent inflation is, as Milton Friedman explained, “always and everywhere a monetary phenomenon.” It occurs when the money supply grows faster than the economy’s actual output, resulting in too much money chasing after too few goods and services. For markets to clear, prices must, on average, rise at a rate equal to the money-supply growth rate minus real economic growth.
Because the Federal Reserve is the country’s sole authority that can set monetary policy, meaning policy that affects the money supply, it is the only entity that can control long-term inflation. Traditionally, it has three tools for doing so.
First, the Fed can set the amount of “base money” in the economy with near precision. This term refers to actual U.S. dollars that can be used to settle transactions: all hard currency in circulation, physical cash in bank vaults, and electronic reserves that banks hold with the Fed. The central bank controls this amount through what are called “open market operations.” When it wants to increase the monetary base, it buys financial assets — usually Treasury bonds — from banks in exchange for money created out of thin air. When the Fed wants to decrease the monetary base, it sells those same assets and extinguishes the proceeds.
Second, the Fed used to set the “reserve ratio,” the percentage of deposits that banks must keep in reserve rather than lend out. The vast majority of money in the economy — all the dollars you see in your bank account — are not dollars at all, but IOUs from banks that function as currency. A lower reserve ratio means banks can lend out more of their deposits, effectively creating more money by adding digits to borrowers’ accounts. A higher reserve ratio constrains lending and thereby limits money creation. Since 2020, however, the reserve ratio has been set at zero, so it is no longer relevant.
That leaves the third tool as the most important of all: interest rates. If the Fed isn’t directing lenders anymore, it must instead influence their borrowers. As the price of money across time, interest rates on various credit products largely determine how much consumers and businesses borrow to finance purchases. At lower interest rates, people borrow more, creating more new money. At higher interest rates, people borrow less, creating less new money.
The Fed can’t force banks to charge any specific interest rate on the front end. Instead, it sets the interest rate on money banks borrow from one another, which is then lent out at a corresponding rate. It does so by setting both a price floor and a price ceiling. For the floor, the Fed pays a risk-free interest rate to banks on their reserves, ensuring that no bank lends money at a lower rate. For the ceiling, the Fed lends openly to banks at a rate 0.25 percentage points above what it pays, ensuring that no bank borrows at a higher rate. With these paired measures, the Fed can keep benchmark interest rates almost exactly where it wants them, within a 25-basis-point range.
When inflation is too high, the Fed is supposed to use its tools to “tighten” monetary policy. In the post-reserve-ratio era, this means shrinking the amount of base money by selling assets and raising interest rates to reduce borrowing. That is exactly what the Fed did beginning in 2022, allowing bonds to roll off its balance sheet in exchange for dollars and upping interest rates from virtually nothing to above 5 percent. And it was working, as yearly inflation fell by half.
But then, when the job was halfway finished, the Fed backed off before the inflation monster was truly vanquished. In 2023, it let the monetary base stabilize. In 2024, it stopped raising interest rates. And, from the end of that year through 2025, it was actively cutting rates — from over 5.25 percent to under 3.75 percent today.
Why? At first, rate cuts were to protect a slowing labor market. By Trump’s second term in office, they were to counteract the economic “uncertainty” caused by the president’s tariff and deportation policies. The inflationary effect was the same: incentivizing more borrowing, loosening the money supply.
Now, the labor market is doing all right. Most of Trump’s tariffs have been struck down, and deportations have cooled off. The remaining problem is inflation, which is twice what the Fed says it should be, according to the latest data. Yet the Fed is keeping interest rates lower than where they were two years ago, and refuses to raise them an inch.
George Will has a good line he likes to use: “To will an end is to will the means for the end.” The means to reduce inflation — the only means — is to tighten monetary policy, which requires higher interest rates. Evidently, the Fed is uninterested in any such policy. Thus, it does not have the will to reduce inflation.
All of this may seem pedantic. What does it matter, really, if inflation is 4 percent rather than 2 percent?
If the past five years have taught us anything about what Americans care about, it matters a lot. We can agree that 2 percent is an arbitrary target, but it’s much better than any higher one. Inflation at 2 percent means that the dollar loses half its value in 35 years. Inflation at 3 percent slashes that timeframe to 24 years. With inflation at 4 percent, your dollar is halved in 18 years. You get the idea.
That’s right, my fellow students of financial literacy: Sometimes the power of compound interest is not your friend.
ADDENDUM: The Federal Reserve will never say it out loud, but one reason it may have to keep interest rates low is to accommodate the national debt. Officially, the Fed has nothing to do with fiscal policy. Practically speaking, if it doesn’t keep rates low forever, the debt explodes and the nation is plunged into an economic crisis. So I think central bankers are thinking about it.
Low interest rates make the debt more manageable in two ways. Directly, they put downward pressure on the rate the government must pay to new bondholders — an expense that is itself charged to the national credit card. More subtly, they cause monetary inflation that steadily erodes the real value of the debt, which is measured in nominal dollars. That is why Milton Friedman labeled money-printing as “taxation without representation.”