• Fed Chairman Kevin Warsh has inherited a dilemma that no FOMC can solve with monetary policy alone.

• So long as Congress runs fiscal deficits of 6% of GDP and the federal debt-to-GDP ratio continues to increase, the FOMC and Chairman Warsh cannot offset the longer-run resulting adverse consequences for the U.S. economy.

• If Congress runs large deficits, the Treasury must conduct ever-larger debt auctions to renew the maturing debt and finance new borrowing.

• If the Fed accommodates the growing deficits with money creation to assure ample liquidity and to suppress interest rates, higher asset-price inflation and/or consumer-price inflation will persist or worsen, distorting and undermining the economy.

• If, on the other hand, the FOMC refuses to monetize the excess debt, the private sector must absorb the expanding supply of Treasury securities. As private capital is siphoned away to finance public borrowing, interest rates will likely rise, slowing the economy and increasing recession risks.

• The only way to avoid this dilemma is for Congress to address America’s real problem: the growing national debt. The FOMC should say as much and stop insisting that it can’t talk about it. The Fed is independent precisely for that purpose.

• The Fed’s large balance sheet is not the problem but a symptom of the problem.

• The problem is that the U.S. fiscal authority is running annual deficits of $2 trillion.

• The problem is that the Federal Reserve System has allowed itself to become subservient to fiscal policy and has adopted an implicit mandate to keep the Treasury market “smoothly functioning” and highly liquid.

• So long as this mandate dominates policy, the Fed’s balance sheet must grow and/or the rules regarding bank capital and liquidity must be eased to allow the private sector to hold more Treasury debt.

• It is no coincidence that, since December 2025, the Fed’s net holdings of U.S. securities have increased $200 billion, approaching a total of $4.5 trillion, and that bank regulators are easing the rules governing both capital and liquidity.

• If the Fed and regulators don’t accommodate Treasury debt growth, interest rates will rise until something breaks. If they continue to accommodate Treasury debt growth, interest rates will be subdued until inflation forces everyone’s hand.

• Only Congress can solve the problem.

The proposed rule is long and highly complex, making it difficult for most readers to assess its implications. The SRC’s comment letter, however, addresses the proposal’s most important issues clearly and concisely. Below is a synopsis of its comments concerning just two of those issues: (1) the proposal’s fallacious arguments regarding the banking industry’s financial performance and competitive standing and (2) the proposal’s probable effects on bank lending. You can read the SRC’s full comment here.

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1. Capital strength has been a performance and competitive advantage for U.S. banks.

Capital is an owner-provided source of funds for banks. Like bank deposits, it is invested in securities, loans, or derivatives that bank management judges to be profitable. The idea that bank capital is a sterile reserve and drag on the banking industry’s performance is wrong.

The SRC’s comment letter points out that since the Global Financial Crisis (GFC), higher capital has been a competitive advantage for U.S. banks — not a burden, and that the banking agencies’ proposal offers no evidence to the contrary. The agencies incorrectly suggest that because U.S. bank capital levels exceed those of European and United Kingdom banks, U.S. banks are at a competitive disadvantage globally. The implication is that international alignment requires the United States to lower its capital standard to the European level.

As the SRC shows, this notion is contradicted by more than a decade of market evidence, during which U.S. banks experienced the most sustained competitive expansion in modern history.

As of year-end 2025, U.S. Global Systematically Important Banks (G-SIBs) held a weighted average Tier 1 leverage ratio of 6.81%, against 4.92% for European and Canadian G-SIBs.[1] Relative strength matters, and it is no coincidence that the better-capitalized U.S. firms commanded dramatically higher valuations, with JPMorgan Chase trading at 2.54 times book value and Morgan Stanley at 2.76 times, compared with 0.77 times for BNP Paribas and 0.82 times for Société Générale. Several European G-SIBs continue to trade below book value. As expected, a premium equity valuation lowers a firm’s cost of capital and provides acquisition currency and retained-earnings capacity.

The SRC also shows that the higher capitalization of U.S. banks brings value in wholesale markets. Clients and counterparties direct flow toward dealers with the balance sheet strength to make markets, extend committed financing, and honor obligations in periods of stress. The decade-long retrenchment of European banks from capital-intensive sales and trading businesses has channeled volume toward U.S. G-SIBs despite — or rather because — U.S. banks have operated under the higher capital levels. A dealer operating at a 6.8% leverage ratio is a more reliable counterparty than one operating at 4.9%. In stressed markets that difference determines which institutions can deploy their balance sheets when clients need them most and which institutions must retrench. Moreover, well-capitalized banks are best able to lend and support growth over the market cycle. Bank counterparties know the value of their banks having higher capital during financial stress.

Finally, U.S. banks’ relatively stronger capital base made them more competitive, enabling them to relentlessly gain market share. In addition to the performance metrics cited above, U.S. banks’ share of global investment banking fees rose from 46% in 2015 to 51% in 2025, reaching 54% in the first quarter of 2026. In contrast, European banks’ share fell from 29% to 21% over the same period — and to 20% in early 2026, the lowest share since records began in 2000. As a result, the five largest global investment banks by revenue are now American firms.

Thus, market evidence shows that the capital advantage of the U.S. banking system has been a strategic asset. Before finalizing a proposal that risks surrendering that advantage by encouraging lower capital among the Nation’s most systemically important banks, the agencies should better analyze the performance and competitive costs of doing so.

2. While the banks and agencies claim that easing capital levels would result in expanded lending, the industry’s actions suggest otherwise.

One of the principal justifications offered for the proposal is that reducing capital levels will expand lending. The SRC’s comment letter, however, points out that market evidence contradicts this claim. Recent actions of the banks offer evidence that banks will use the lowering of standards as an opportunity to return capital to shareholders through buybacks and dividends, which would not translate into increased lending to the real economy.

In response to lower capital standards implemented over the past year, for example, banks have returned unprecedented amounts of capital to shareholders. In the first quarter of 2026, U.S. banks executed a record $33 billion in share repurchases, with JPMorgan Chase, Goldman Sachs, and Citigroup each completing their largest quarterly buybacks. Repurchases exceeded analyst projections by 30% to 50%, and Goldman Sachs alone returned $6.38 billion to common shareholders during the quarter. No G-SIB used its first-quarter results to announce an expansion of lending to households or businesses.

There should be no objection to returning capital to shareholders as earnings allow. But concern should be raised when doing so weakens both the industry’s financial and competitive strength with little evidence that promised lending will follow. The agencies should be cautious before changing a model that has allowed the U.S. banking industry to outperform and outcompete its global rivals.

[1] Bank Capital Analysis Semiannual Update, 4Q 2025 (Federal Reserve Bank of Kansas City, December 2025),

https://www.kansascityfed.org/documents/16411/Bank_Capital_Analysis_-_4Q_2025.pdf

In recent months much has been written regarding the rapid growth of private credit (PC) and related risks incubating within the financial system. This concern has been intensified by the surprise failures of private credit borrowers and subsequent investor runs on private credit firms.

While the industry does not appear to pose an immediate systemic risk to the financial system, its rapid growth, expanding leverage, and complex ties within the financial industry deserve attention before private credit becomes the unexpected force that undermines the financial system.

Private credit

In its simplest form, private credit is direct lending by nonbank institutions, business development companies (BDCs), or other asset managers to highly leveraged companies. The loans are not publicly issued bonds and are usually not traded in liquid public markets. They are privately negotiated, often senior secured, floating-rate, and commonly held until maturity or refinancing.

The private credit borrower is typically a middle-market company: too large or complex for ordinary small-business lending, but too leveraged or too opaque for traditional bank lending or the public bond market. Some are backed by private equity sponsors.

Private credit funds are ready lenders because they can offer borrowers greater speed, flexibility, certainty of execution, and confidentiality. Given these advantages, it isn’t surprising that private credit funds have experienced extraordinary growth in recent years.

The Federal Reserve estimated in 2024 that the U.S. total private credit market had reached nearly $1.7 trillion, making it comparable in size to the leveraged loan and high-yield bond markets. Using slightly different definitions and a broader global perspective, the Bank for International Settlements (BIS) and the Financial Stability Board (FSB) estimate that private credit fund assets under management have grown from about $2 billion in the early 2000s to between $2.0 and $2.5 trillion today.

While estimates vary, the conclusion is the same: Private credit has evolved from a niche financing source into an increasingly important component of corporate credit markets.

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Factors behind private credit’s growth

Several factors have contributed to this growth. First, as the banking industry argues, the post-Great Financial Crisis capital and liquidity requirements made some forms of leveraged corporate lending less attractive for commercial banks. Second, the prolonged low-interest-rate period after 2008 encouraged qualified investors to seek higher-yielding alternatives to public bonds, and private credit helped meet that demand. Finally, borrowers value the private credit model. Companies can obtain tailored financing packages more quickly from a small group of direct lenders than through a public syndication or a more cautious commercial bank.

How are private credit firms funded?

On the supply side, private credit firms are funded with long-term investor capital. Sources include, for example, pension funds, insurers, sovereign wealth funds, endowments, private funds, family offices, and high-net-worth individuals. These sources — the limited partners — commit capital to a fund for multiple years, and managers draw on that capital as loans are originated, thus protecting the fund from unexpected short-term liquidity events.[1] Thus, the growth in the supply of capital through private credit and the explosive demand for leveraged capital among mid-tier firms to fund acquisitions, refinancings, and balance sheet growth has made this market a mainstay in corporate finance.

Unlike banks, however, private credit funds have no access to insured deposits or to central bank liquidity facilities. Consequently, to maintain investor confidence, they historically have operated with far less leverage than do commercial banks. The IMF reports that the typical private credit fund has maintained debt-to-equity ratios ranging from roughly 0 to 1.3 times, while BDCs often operate around 0.8 to 1.2 times. In contrast, the commercial banking industry, which benefits from both deposit insurance and central bank liquidity, operates with total debt-to-equity ratios averaging 10 to 1.

Thus, while both commercial banks and private credit funds are corporate lenders, they cover their risks in very different ways.

Also, while private credit may compete with banks in the direct lending arena, it is at times an attractive loan market for banks. When banks lend to private credit, they may mitigate risks that come when lending directly to the private credit borrower. Banks commonly lend to private credit using secured credit or senior tranches, which enables them to diversify across portfolios, capital-call rights, or overcollateralization. The Federal Reserve Bank of Kansas City, for example, found that bank loans to private credit funds had lower predicted default rates than ordinary commercial and industrial loans. As a result, these loans carried lower risk-weighted capital requirements while generating risk-adjusted returns as high as 30%.

In summary, the private credit industry provides several benefits to credit markets. For borrowing companies, it supplies capital when banks or public markets are unavailable, slow to respond, or unwilling to lend. It finances acquisitions, firm expansions, refinancings, working capital needs, and a variety of asset-based projects. The bilateral relationship between lender and borrower can make workouts easier because lenders can amend terms faster than a dispersed bondholder base.

For investors, private credit provides higher returns than they receive from other investment options. And for the economy more broadly, private credit diversifies the supply of credit, making middle-market firms less dependent on traditional banks to meet their liquidity needs and support their operational growth.

Private credit’s changing structure

While the industry’s success is noteworthy, market conditions are changing. Interest rates are higher, the economy is less certain, investors are more cautious and, thus, maintaining its funding base has become more difficult. Accordingly, the industry has been modifying its operating framework, adding leverage, seeking new funding sources, and shortening its liability structure. Simply stated, it is increasing its overall risk profile.

More leverage, more complexity

For starters, private credit funds have increased their reliance on leverage. BDCs, for example, which had been subject to debt-to-equity limits of 1:1, have seen those limits increased to 2:1. Private credit funds also have added a host of debt vehicles to their sources of funding. These include bank subscription lines of credit backed by investor commitments, facilities backed by loan portfolios, net-asset-value (NAV) commitments, asset-backed lending, repo-style financing, and private credit collateralized loan obligations (CLOs).

As the use of these instruments has grown, the BIS estimates that private credit leverage has risen from about 0.4 times debt-to-equity in 2011 to more than 1.0 times on average in 2024. Some recent estimates place private credit CLO debt-to-equity ratios as high as 6 to 1.

As private credit employs more leverage to fund an already highly leveraged borrower, its vulnerability to an economic shock increases accordingly. The FSB reports that private credit borrowers are often rated around single-B credit quality and that external estimates place borrower leverage at five to six times debt-to-EBITDA, compared with roughly four times for leveraged loans. Also, because some accounting adjustments can make leverage appear lower than its economic reality, the FSB noted that “true” leverage in some private credit deals is closer to seven times debt-to-EBITDA.

Growing interconnections and conflicts

A further change within the industry beyond the level of leverage is its context. Private credit firms are affiliated with some of the largest private equity (PE) funds searching for convenient sources of funds for their subsidiary operations. For example, The Wall Street Journal reports that PE-owned insurance companies are investing policyholders’ money in private credit products sold by parent firms or affiliated interests. Examples of asset managers entering this realm include Apollo and Brookfield. Volume estimates of inter-affiliate funding arrangements show a sizable increase, from hundreds of millions in 2002 to billions of dollars today.

Embedded within such arrangements are inherent conflicts of interest that pose unique risks. If banking history is any indication, for example, inter-affiliate transactions function smoothly during economic growth years, but in periods of economic contraction, they are often abused as liquidity is sought from the well-funded to the cash-starved affiliates.

Expanding access to retail capital

Finally, the private credit industry is seeking to broaden its source of funding by gaining greater access to retail investors, including through 401K retirement plans. Proponents argue that such access would allow retail investors to participate in potentially higher-return investments. The assumption is that plan trustees can make sound investment choices among competing PC funds.

Nevertheless, the more private credit funds become embedded in retail-oriented institutions, the greater the pressure will be to bail out retail investors and by extension private credit investors more broadly should a financial crisis occur and the most highly levered transaction suddenly unwind.

Risks going forward

Currently, despite its growth and recent problems, the private credit industry does not appear to pose a systemic risk to the broader financial industry. Moody’s reported, for example, that as of June 2025, U.S. banks had approximately $300 billion in loans outstanding to private credit providers, about $285 billion to private equity funds, and roughly $340 billion in unused lending commitments to those borrowers. In total, this represents only about 3% of U.S. commercial banks’ assets. Its footprint to other sectors also remains relatively modest.

Early warning signs

Still, the private credit industry is showing signs of strain. The failures of First Brands and Tricolor in 2025 shook confidence by exposing weaknesses in underwriting, collateral controls, and transparency. In addition, the opacity of PC balance sheets and the resulting uncertainty regarding asset quality have triggered investor outflows and weakened investor confidence.

These outflows were not bank runs in the classic deposit-funded sense. Private credit firms have locked up capital and repurchase limits designed to prevent forced sales of illiquid loans. Nevertheless, the borrower failures and subsequent market reaction illustrate the semi-liquid nature of private credit products and the market friction that can follow a loss of investor confidence. Firms as large as BlackRock and Morgan Stanley, for example, found it necessary to restrict withdrawals after redemption requests rose, in one case reaching nearly 11% of shares outstanding.

Such events serve as a warning

While private credit is a useful source of capital for mid-tier and higher-leveraged borrowers, the related risks and shortcomings are real. The industry has grown exceptionally fast, and it is employing greater leverage and adding complexity to its balance sheet. The industry also is known to employ payment-in-kind features within its loan portfolio to keep loans out of the nonperforming designation. At the same time, however, its balance-sheet reporting is opaque, and asset valuations are subject to management bias. At a minimum, such practices justify the call for greater balance sheet transparency and better reporting on inter-affiliate transactions.

Finally, while the private credit industry’s risk profile appears manageable, that assessment may change as private credit grows in scale and scope. Experience should remind both the industry and policymakers that innovative entrants into finance seldom start as immediate sources of systemic risk. As private credit expands, leverage increases, and access to retail and related institutional funding broadens, its systemic risk profile will increase, perhaps significantly.

Thus, the financial system would benefit if policy demanded clearer accounting standards and reporting guardrails regarding capital and leverage, and greater transparency surrounding inter-affiliate transactions. It is a matter of time before the next financial crisis arrives, and appropriate guardrails could help prevent private credit from becoming its source.

Sources used include: Jordan Pandolfo, “Banks and Private Credit: Competitors or Partners?” Federal Reserve Bank of Kansas City, Economic Bulletin, March 2025. Fernando Avalos, et. al., “the global drivers of private credit”, BIS Quarterly Review, March 2025. “Report on Vulnerabilities in Private Credit”, Financial Stability Board, May 2025. “Private Credit Fault Lines”, Thoughts from the Frontline, November 2025. Pete Vatev, “Private Credit’s Surge Has Investors Excited and Regulators Concerned”, Enterprising Investor, CFA Institute, June 2025. Cai, Fang and Haque, Sharjil, “Private Credit: Characteristics and Risks” Federal Reserve Board, February 2024. Berg, Jeffrey, et al., “US banks’ private credit loan exposure nears $300 billion”, “Banks fund the competition: The rise and risk of lending to non-bank lenders” Moody’s, October 2025.

[1] However, this is changing as BDCs and interval-style funds have introduced various liquidity features designed to attract retail investors.

Chairman Warsh is setting up five task forces to study and recommend how the FOMC should communicate, how to use its balance sheet, improve its data sources, think about employment, and build its inflation framework. Those are all worthy endeavors, but he said this won’t be finished until this fall or year-end. In the meantime, decision must be made and these task forces should not become a reason for postponing decisions. This would be as detrimental to the markets and economy as too much forward guidance.

The Chairman is on the right path, and we wish him and the FOMC every success.

The Iran war has made the economic outlook for 2026 more complicated and policy more difficult to define. For much of the remainder of the year, the country is likely to remain in an inflationary boom: growth supported by fiscal stimulus, asset-price strength, and deficit spending, but increasingly pressured by rising prices, higher interest rates, and geopolitical uncertainty.

Importantly, much of this boom was in motion before the Iran war began. The One Big Beautiful Bill, with its tax cuts and additional government spending that took effect on January 1, added momentum to an economy that was already benefiting from lower interest rates. Adding fuel to this growth is a federal government spending roughly $6 trillion while collecting about $4 trillion in revenue. That large and growing deficit is providing a powerful financial push to Wall Street, asset values, and the broader economy.

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Because this is an election year, there is little likelihood of meaningful spending restraint before voters go to the polls. Fiscal policy is therefore likely to remain stimulative through the fall. In addition, part of the deficit has been financed by the Federal Reserve through a renewed form of quantitative easing. That support increases asset values, creates a wealth effect, and adds further demand to an already inflation-prone economy.

The Iran war now adds a new layer of uncertainty. Alongside the price effects of tariffs, the war and rising fuel prices have further increased inflationary pressures while also beginning to slow parts of the economy. That drag may become more visible in the second half of the year, with the most significant impact appearing after the fall elections and into 2027.

Interest Rates

The obvious question that follows this outlook is what it means for interest rates. With deficits rising, inflation proving more persistent than expected, and uncertainty growing around the supply shocks of the Iran war and related geopolitical risks, interest rates across much of the yield curve are moving higher. Paradoxically, these emerging conditions may place added pressure on the Fed to intervene and to buy securities along the yield curve to keep rates from rising. But that response carries its own risks. If investors believe the Fed is monetizing deficits or losing discipline on inflation, renewed asset purchases could stoke inflation fears and push rates even higher. I suspect the Fed will hold its policy rate steady but allow the yield curve to steepen, expecting that by doing so the inflationary impulse will be suppressed.

The New Fed Chair and Policy

Kevin Warsh, like Jerome Powell, is an experienced consensus builder. He is diplomatic, measured, and skilled at working through institutional differences. Those qualities will be essential as he works with the members of the Federal Open Market Committee.

Warsh’s economic philosophy, however, differs from Powell’s. Warsh is likely to be more concerned about avoiding a further expansion of quantitative easing, especially given his goal of shrinking the Fed’s balance sheet. That will not be an easy position to manage. Views on the balance sheet differ across the FOMC, and finding consensus on this issue may prove difficult.

He will also have to navigate divided views on future rate policy. Some members will be reluctant to see rates rise if the economy is slowing. Others will be more inclined to raise rates to address the growing inflation problem. Warsh’s challenge will be to lead the FOMC toward the best choice and then build consensus at a moment when markets are looking for clarity.

Fed Independence

Fed independence will become an increasingly important issue. The Administration will likely expect a more cooperative Federal Reserve, particularly if growth slows or financial conditions tighten. Warsh will therefore need to set expectations early regarding his own commitment, and the FOMC’s commitment, to price stability.

That may be his most important task. In an environment of large deficits, rising geopolitical risk, persistent inflation, and political pressure, credibility will matter as much as policy. If Warsh can preserve the Fed’s independence while guiding the committee through a divided and uncertain period, he will have a chance to maintain market confidence. If not, the inflationary boom of 2026 could give way to a more difficult economic environment in 2027.

Independence, however, does not guarantee those outcomes.

The question that remains looks beyond the usual praise of central bank independence. It asks what happens when an independent central bank uses its discretion to suppress interest rates for an extended period and to engage in large-scale asset purchases, thereby injecting substantial amounts of base money into the economy.

What if such discretionary policy inflates asset values, pushes wholesale and consumer prices higher, and misallocates resources? If central bank independence can lead to such outcomes, is it still the best arrangement?

From Independence to Fiscal Dominance

Over the past two decades — and in earlier periods — the Federal Reserve has adopted policies that, in theory, central banks were designed to avoid. While it provided liquidity in crises, it then went on to suppress and hold interest rates near zero, it purchased and held exceptionally large quantities of government securities and created sizable reserve liabilities well beyond the period of crisis. These policies contributed to episodes of asset and price inflation and notable misallocations of resources.

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Also, the Fed has at times shown a reluctance to assert its authority to say “no” to monetizing the national debt. The ecosystem around monetary and fiscal policy — Congress, the Treasury, and Wall Street — has come to expect the Fed to make large purchases of Treasuries as a regular feature of monetary policy, not an exceptional response to extraordinary circumstances.

This pattern has left the central bank misaligned with its mandate and, in practical terms, less independent to pursue price stability, which is needed for maximum employment. The United States now faces, or is dangerously close to, fiscal dominance: a situation in which the central bank’s primary objective — stable prices — becomes subordinate to the Treasury’s financing needs.

The Scale of the Shift

To gauge where we stand, consider the following developments between 2005 and 2025:

• The gross federal debt has grown nearly fivefold, from about $7.9 trillion to $39 trillion.

• The Fed’s holdings of securities increased more than eightfold, from roughly $800 billion to $6.4 trillion.

• The Fed’s reserve liabilities ballooned about 350-fold, from $8.4 billion to $3 trillion.

• The Consumer Price Index rose roughly 1.7x.

• The Standard & Poor’s 500 index surged about 5.5x.

These numbers underscore how susceptible the Fed is to fiscal dominance and how far monetary policy has drifted from a clear, price-stability mandate. If the Fed is to remain independent in any meaningful sense, it must withstand the gravitational pull of fiscal commitments and market expectations that encourage it to fund government outlays or to “lean with” debt issuance through monetary expansion.

A Framework for Boundaries

What, then, is the prudent path forward?

The core proposition remains that central bank independence must be preserved, but that there must also be clear, enforceable boundaries around its discretion. The aim is to ensure that the central bank can navigate normal economic cycles without structural political entanglement, while operating under a credible, durable constraint that prevents the kind of unbounded monetization that could erode price stability and long-term economic health.

A practical mechanism for achieving this balance between independence and constraint is to establish fixed boundaries on the central bank’s ability to create reserves or set interest rates.

The boundaries should be broad enough to allow the central bank to respond to typical macroeconomic conditions, but firm enough to deter persistent policy misalignment with price stability and financial stability objectives. Within this framework, temporary exceptions would be permitted to address urgent, unforeseen circumstances, but with a clear, time-bound return to preset limits to ensure that the exception does not become the rule. To remain outside the boundaries would require Congressional approval.

In short, central bank independence remains essential, but should be complemented by credible, legislated guardrails. These guardrails would do the following:

• Preserve the central bank’s ability to conduct monetary policy through business cycles.

• Prevent it from becoming a perpetual enabler of fiscal expansion and financial leverage via unlimited asset purchases or reserve creation.

• Ensure that exceptions to the boundary rules are not a perpetual fixture but a temporary, auditable deviation with a clear path back to established constraints.

• Strengthen the independence of price stability by disincentivizing the use of monetary policy to finance the fiscal deficit on an ongoing basis.

The ultimate objective is not to eliminate reasonable discretion but to protect the central bank’s credibility and the nation’s long-run economic health. A central bank that operates within transparent, enforceable boundaries is less vulnerable to short-term political cycles or self-imposed drift that distorts asset prices and misallocates resources.

The Case for Legislative Constraints

Critics will no doubt argue that Congress cannot be trusted with the responsibility to set such boundaries.

In my view, money and credit fall within the purview of Congress, and if the Fed seeks to pursue experimental or extreme monetary policy as a persistent feature, it should be subject to congressional authorization. No system is perfect, and insulating a central bank from short-term political pressures should be a priority.

However, allowing a central bank or any committee to operate without boundaries erodes the very independence being sought by increasing its susceptibility to political influence and undermining the core mandates of price stability, maximum employment, and long-term economic growth and stability. If we accept that central banks should have discretionary authority, we must also accept that such discretion cannot be unfettered.

Independence Requires Boundaries, Accountability, and Transparency

This is not an argument against independence. It is a means of disciplining independence — one that recognizes the potential costs of unchecked discretion and seeks to protect both the central bank’s credibility and the public’s confidence in the monetary regime.

In the end, independence without accountability risks drifting toward a policy that undermines its own aims. Boundaries, combined with accountability and transparency, are the prudent path to a stable and resilient monetary order.

[1] See, for example, Alberto Alesina and Lawrence H. Summers, “Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence,” Journal of Money, Credit and Banking 24, no. 2 (1993); Alex Cukierman, “Central Bank Independence and Monetary Policymaking Institutions—Past, Present, and Future,” European Journal of Political Economy 24, no. 4 (2008); Francesco Giuli, Serena Ionta, Valeria Patella, “Monetary/Fiscal Policy Dominance and Conflicts: Evidence from Crises,” Economics Letters 257, (December 2025).

Anticipating the course of the U.S. economy is always difficult, but the challenge is unusually great at present. The country is navigating trade and military conflicts, funding a massive and growing national debt, and dealing with a difficult transition in Federal Reserve leadership. These developments do not operate independently. They interact, shaping the outlook for inflation, interest rates, and economic growth and stability.

The near-term outlook may be stronger than many expect, but the forces supporting that growth may be reinforcing inflationary pressures, setting the stage for a more difficult adjustment later.

A Political and Fiscal Starting Point

A useful point of departure is the political setting in which fiscal and monetary decisions are being made. Congress, both parties, and the administration remain focused primarily on short-run political objectives, above all reelection. Accordingly, it is reasonable to assume that the nation’s chronic deficit and budgetary problems will continue to be deferred rather than addressed. That helps explain why near-term growth is likely to remain firm. It also suggests, however, that short-run economic support is being purchased at the cost of greater long-run vulnerability.

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Sources of Near-Term Economic Strength

The case for continued growth through 2026 is straightforward. Fiscal policy is expansionary and likely to remain so over the next year. The fiscal stimulus that began in January will continue to support GDP growth through the remainder of the year. The new tax cuts put in place in January will remain in effect. There will be no meaningful reduction in spending, and there will be a further increase in spending for the war in Iran.

These measures alone are sufficient to support aggregate demand.

The government sector, however, is not the sole source of momentum. The private sector is also contributing materially to the economy’s current strength. U.S. investment in AI will exceed $500 billion this year. Corporate earnings remain strong, and investment in other sectors should remain modest but steady. Consumers who have benefited from rising asset values will continue to spend out of those gains. Labor markets should remain steady as lower demand for labor is offset by lower supply. Labor productivity also remains a notable positive, at 2% or better, as technology continues to advance.

Taken together, these conditions form a strong case for continued expansion through 2026.

The Inflationary Character of the Expansion

The fact that growth may continue does not mean that the expansion is well balanced. The principal concern is that the same policy environment supporting activity is also imparting an inflationary bias. Expansionary fiscal policy in an economy that already has momentum adds demand to the system and raises the probability that inflation, asset and consumer prices, accelerates above a level consistent with long-term stability.

The distributional effects of this environment are also important. Consumers with rising asset wealth can continue spending, supported by appreciating portfolios and balance-sheet gains. Lower-income households, by contrast, face a more difficult situation. Their wealth is limited, and their incomes struggle to keep pace with inflation. Accordingly, some of what appears in the aggregate data as broad consumer resilience is, beneath the surface, more concentrated and less durable than headline figures suggest.

Energy, Trade, and the Risk of Stagflation

A second source of concern lies in the interaction of energy shocks and tariff-related disruptions. These pressures push inflation higher while also weighing on real growth — raising the risk of stagflation. The OECD estimates inflation will reach 4.2% later this year. If that occurs in the context of weaker trade efficiency, higher energy costs, and persistent fiscal expansion, the risk of stagflation becomes real.

Stagflation is especially difficult because it limits the effectiveness of any policy response. Measures designed to support growth may worsen inflation, while measures designed to restrain inflation may deepen the slowdown in growth. Cost shocks, trade frictions, and war-related pressures can become embedded in expectations, and should that occur, the line between a temporary inflation problem and a more persistent one becomes harder to maintain.

Fiscal Imbalance and the Debt Overhang

The fiscal backdrop intensifies these concerns. The federal deficit will exceed $2 trillion, and the debt will exceed $40 trillion by year-end. These figures are consequential not merely because of their scale, but because of the constraints and incentives they create. Persistent deficits place pressure on Treasury markets, reduce fiscal flexibility, and increase the likelihood that policymakers will rely more on monetary accommodation to ease the burden of financing. Over time, large and recurring borrowing requirements affect the relationship between the Treasury and the central bank, particularly when political incentives favor low nominal rates and continued spending.

The fiscal problem is therefore not separate from the inflation problem. It is part of it. Large deficits, when sustained into a period of already firm growth, make it more difficult to restore price stability without either tightening financial conditions significantly or tolerating further inflation. That tradeoff becomes more severe as debt levels rise.

The Dollar and External Pressures

The outlook for the dollar adds another layer of uncertainty. The U.S. dollar may remain temporarily strong as a safe haven, particularly in a world marked by geopolitical conflict and financial stress. But that strength should not be treated as permanent or self-sustaining.

Tariffs, persistent trade deficits, and possible shifts in capital flows tied to geopolitical developments could weaken the dollar over time. A weaker dollar would add to inflation pressure through higher import prices and could further complicate the already difficult balance between economic growth and price stability.

The Federal Reserve and the Problem of Accommodation

The Federal Reserve also is central to this outlook, and under present conditions it appears more likely to accommodate fiscal policy than to resist it. It has adopted the implicit mandate of ensuring liquid, smoothly functioning money and government debt markets, even if that means inflation remains above its announced 2% target.

The nominal Fed policy rate is 3.6%, but when adjusted for 3% inflation, the real policy rate is less than 1%. That is an accommodative setting in today’s economy, and it will become more so if inflation rises further, as it did last month, unless Fed raises nominal policy rates. The politicians and Wall Street, however, will put heavy pressure on the Fed to keep nominal rates low. While the Fed may resist cutting rates, it will also be very hesitant to raise them unless inflation moves above 4% and remains there for some period.

There is also the matter of balance-sheet policy. Since last December, the Fed has restarted its purchases of Treasury securities, adding more than $210 billion of securities to its balance sheet. In practical terms, that converts government debt into money. This is the essence of debt monetization. It makes fiscal deficits easier to finance and harder to discipline through market mechanisms.

The justification for these purchases is the need to preserve orderly market functioning. No policymaker wants disorder in money or Treasury markets. But market stabilization does not eliminate the tradeoff. If the Fed accommodates too much for too long during a period of large deficits and persistent political pressure, the likely result is not stable expansion. It is higher asset and price inflation in the near term and a more difficult correction later.

Outlook for 2026 and Early 2027

Sorting through the turmoil, the most plausible near-term outlook is that the U.S. economy will experience a mild inflationary boom through most of 2026. Real growth should exceed 2% as fiscal and monetary stimulus temporarily overshadow tariff and energy shocks.

Looking beyond this year, the outlook is less favorable. As the economy moves into 2027, inflation is likely to have risen and to remain elevated as the fiscal conditions worsen and lagged effects of higher energy prices, trade frictions, and war work further into the economy. If nothing is done to alter that trajectory, the Federal Reserve will eventually be forced to raise rates. And if it acts only after inflation has become more deeply embedded, the response will need to be more forceful, and the risk of a slowdown or recession greater.

This outcome is not inevitable. But it should be central to any serious assessment of the next two years. Strong growth in the near term may conceal the extent to which inflationary and financial pressures are accumulating beneath the surface.

New Fed Leadership and the Treasury–Fed Relationship

The coming transition in Fed leadership introduces an important additional question. Kevin Warsh, the nominee to replace Jay Powell as Fed Chair, has indicated a commitment to avoiding the outcome described above. He has proposed a Treasury–Fed accord, similar to the one established in 1951, under which the Fed would conduct policy independently of the Treasury’s debt-management needs.

That accord reestablished the principle that monetary policy would be guided by long-term price stability, not short-term fiscal convenience.

Warsh’s apparent goal is to honor that principle by having the Fed, with Treasury’s cooperation, shrink the size of its balance sheet, change its composition, and in doing so promote stable growth and moderate interest rates. It is a worthy objective, but it will be difficult to achieve given the current outlook.

During the 1950s, when the earlier Treasury-Fed accord was in force, federal deficits averaged a relatively low 3% of GDP, and Congress ran budget surpluses in three instances. Those conditions eased pressure on Treasury markets and gave the Fed more room to pursue price stability without having to raise rates aggressively.

The present environment is markedly less favorable. Deficits exceed 6% of GDP and are expected to remain elevated through the next decade. That makes it far more difficult to simultaneously shrink the balance sheet and keep rates low. Warsh and the FOMC nevertheless will face immense pressure from Congress and the administration to monetize the accelerating national debt and suppress rates. Thus, the challenge isn’t just the Fed’s to manage. It is political. Government deficits must be addressed first.

Conclusion

The U.S. economy may remain stronger in the near term than some expect. There is real momentum coming from fiscal policy, private investment, labor productivity, and spending. But strong near-term performance should not be confused with long-term stability. If deficits remain unchecked, if monetary policy stays too accommodative, and if inflation continues to build, the eventual adjustment will be harder, not easier.

The outlook is not fixed. Deficits can be restrained. Monetary policy can find better balance. Growth can continue without allowing inflation to become the defining feature of the expansion. But that outcome will depend on discipline in fiscal policy, discipline in monetary policy, and a willingness to look beyond the short run.

Chairman Lucas, Ranking Member Vargas, and members of the Task Force on Monetary Policy, Treasury Market Resilience, and Economic Prosperity, thank you for the opportunity to discuss “Revisiting the Treasury–Fed Accord.” The purpose of the original accord was to clarify roles and responsibilities between the US Department of the Treasury and the Federal Reserve System (Fed), both among the most important financial institutions in the world. The question of a new accord comes at a time when the US is running ever larger fiscal deficits, and monetary policy is under increasing pressure to help the Treasury smoothly fund those deficits; some fear this funding comes at the expense of too-high asset and consumer price inflation.

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I appreciate this opportunity to share my perspective on the topic, and I begin with my conclusion: An accord is needed, but I would emphasize that to be successful, it also will need the explicit support of Congress.

Over the past nearly two decades, the Fed and Treasury have expanded their roles within the economy. The Fed has been an increasingly significant buyer of Treasury debt, first to inject liquidity into the economy during crises, but then to support Treasury funding of an ever-larger national debt. The Fed’s support has helped keep interest rates stable and low. This situation is similar to what occurred in the period following World War II, when the Fed bowed to the Treasury’s insistence that the Fed help fund the nation’s debt at low interest rates.

In 1951, the Fed regained its independence from the Treasury by negotiating an accord that defined their respective roles and recognized that the Fed should focus on price stability and not be involved in fiscal policy. Circumstances today mirror that period, and the idea of a new Treasury–Fed Accord is a timely one.

The Fed’s Expanding Mandates

The Fed’s legislative mandate is to conduct monetary policy “so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”1 In pursuit of these goals the Fed has remained mostly insulated, or independent, from short-term political control and influence.

In theory, when the economy is growing too slowly or below potential, the Fed can lower policy rates, as it judges necessary, to stimulate the economy to bring it back to potential. That’s the easy part of independence. When inflation is increasing, or threatening, because of too-rapid credit growth or related factors, the Fed can raise rates to slow the economy and bring it back to normal. That’s the harder part of independence.

When there is a crisis, a liquidity crisis for example, the Fed provides a temporary liquidity facility to preclude a possible collapse of the system. But then, as quickly as possible, the Fed is expected to remove the stimulus and return to a more normal policy, thereby minimizing the likelihood of unintended distortions within the economy.

In practice, however, the Fed has taken on an expanded role in financing the nation’s growing debt. Over time, an independent Fed, with no objection from Congress or administrations, has broadened its interpretation of the mandate, and at its own discretion has deepened and extended its role in fiscal matters and within the financial economy. This evolution toward fiscal policy is well illustrated in the way the Fed has operated since the great financial crisis (GFC) of 2008.

Although the GFC ended in 2009, the Fed continued its use of large-scale asset purchases of government and government-guaranteed debt—a practice called quantitative easing (QE)—into the next decade. This exceptional policy became one of the Fed’s standard operating tools, teaching Congress and the Treasury that it was a ready buyer of the federal debt. Between 2010 and 2015, for example, the Fed’s balance sheet increased from $2.3 trillion to $4.5 trillion. After the pandemic, the Fed again extended its QE program, increasing its balance sheet to nearly $9 trillion. Through these QE programs the Fed has come to dominate the Treasury debt market and has weakened the market’s role in controlling the government’s propensity to spend and borrow.

The Fed also purchased mortgage-backed securities during the GFC and still holds them today. These purchases further expanded the Fed’s fiscal reach by supporting the housing market, which at the time was under severe stress. While well intended, the purchases involved the Fed in a form of credit allocation, an issue that is proper to fiscal rather than monetary policy.

In 2019 and 2020, the Fed again engaged in large-scale asset purchases to support a highly leveraged government securities market that ran into difficulty from a significant spike in the securities repo rate. The purpose of the Fed’s intervention was to keep the Treasury market calm and operating smoothly, and to avoid economic volatility. It is noteworthy that the temporary liquidity intervention continued into 2020, well after the September 2019 repo rate spike.

Recently, the Fed began offering the banking industry a standing repo facility. This facility is a substitute for the discount window and is much easier for banks to access. It may be accurate to say that the facility makes the Fed the lender of first resort, the goal being to ensure that the Treasury market functions smoothly, remains highly liquid, and stays elastic as it grows ever larger.

My concern is that these Fed actions have left in their wake a less independent central bank, a less accountable market, and, I fear, a less constrained government budgeting process. There is now a deep-seated expectation on the part of the Treasury, Congress, Wall Street, and even some within the Fed, that the Fed has an implicit mandate to intervene as necessary to maintain asset values and a smoothly functioning securities market. The risk is that by embracing this mandate, the Fed also implicitly accepts the tradeoff of higher inflation in assets and consumer prices. For example, this past December the Fed lowered its policy rate and restarted QE, although inflation at the time remained close to 3 percent, already above the Fed’s 2 percent inflation target.

To get a further sense of the effects of the government’s growing debt and Fed’s expanded mandate, here are some economic trends that occurred between 2005 and 2025:2

• Nominal GDP increased two and a half times, from $13 trillion to more than $30 trillion, while real GDP has increased one and a half times.

• The Consumer Price Index (CPI) almost doubled (increased 1.7 times).

• The gross federal debt increased 4.8 times, from about $8 trillion to over $38 trillion, exceeding 100 percent of GDP.

• The Standard & Poor’s 500 index increased 5.5 times.

• The median price of a home increased 1.6 times.

• By contrast, real weekly earnings, wage and salary, increased 1.1 times over that same period.

The above numbers show how significantly large government spending and the Fed’s monetary accommodation affected US asset inflation and the CPI over a relatively short period.

Gross federal debt will reach $40 trillion this year. The US will add another $2 trillion to its debt this year and each successive year for many years to come. Should demand for Treasury securities among foreign or domestic buyers slow relative to this increasing supply, it would put upward pressure on interest rates. The Treasury would most likely expect the Fed to increase purchases of the debt to keep markets calm and prevent rates from rising.

This past fall, for example, the secured overnight financing rate rose above the Fed’s target rate, reflecting, in part, tightening liquidity conditions in the Treasury market. Not long after this, under the heading of assuring ample bank reserves, the Fed restarted QE by purchasing $40 billion per month of government securities. These purchases average close to 25 percent of the monthly increase in the nation’s debt. This action adds liquidity to the market and helps contain the cost of debt-financed government expenditures. But it also accelerates the growth in bank deposits and the money supply and, over time, contributes to asset and price inflation.

Had the Fed chosen not to purchase the $40 billion of Treasury securities per month, would a successful Treasury auction have required higher interest rates? Given the Fed’s implied mandate to assure a smoothly functioning Treasury market, did the Fed expand its balance sheet to accommodate this mandate instead of moving inflation more deliberately to the 2 percent goal? These are fair questions given the rapidly expanding national debt. Under current conditions, it seems likely that pressure will only build for the Fed to monetize future debt, thereby leading to fiscal dominance.

A New Treasury–Fed Accord

So long as the Fed continues to monetize the nation’s deficits, asset and price inflation will follow. Stable prices cannot be achieved without fiscal and monetary policy discipline. Fortunately, there is a playbook that points toward a solution. After World War II, the US had a similar problem. The federal debt was over 100 percent of GDP, and Treasury expected the Fed to keep interest rates low in order to keep the cost of the federal debt low. Inflation was also increasing, however, and the Fed could no longer both suppress interest rates on Treasury debt and control inflation. Treasury rates would have to be allowed to increase, raising the government’s costs of debt.

The conflict between the Treasury and the Fed was tense, so much so that President Truman called the entire Federal Open Market Committee (FOMC) to the White House to resolve the conflict. Ultimately, a compromise was reached in the form of the Treasury–Fed Accord of 1951, which confirmed the Fed’s right to set interest rates independent of the Treasury.

A new Treasury–Fed Accord that scales back the Fed’s role in the Treasury debt market is needed. The Fed must be allowed to focus on price stability, in terms of both assets and CPI. QE should not be a means to monetize Treasury debt. Importantly, also, such an accord does not have to shock the economy. It can be implemented over multiple years, allowing time for the government to reduce its deficits and for the Fed to concentrate on its price stability mandate. A reduction in the deficit from 6 percent to 3 percent, for example, would greatly reduce pressure on interest rates, facilitate private investment, and enable the economy to grow out of its debt dilemma.

To give you a picture of how this could evolve, consider the 10 years following the 1951 Accord. The debt-to-GDP ratio fell from 90 percent to 55 percent, and government deficits over the period averaged below 3 percent of GDP. Real GDP growth averaged near 4 percent while inflation averaged less than 2 percent. Such outcomes benefit all.

Admittedly, today’s economy is different from that of 1951. While the fundamental problem is the same, which is that the nation’s debt relative to income (GDP) is excessive, in the 1950s deficits were less severe, with surpluses in some years. Today it will be difficult to throttle back the nation’s growing deficits, which makes it difficult for the Treasury to fund the ever-rising debt without Fed backup. The pressure to monetize the debt will only increase as annual deficits continue.

Finally, assuming the deficit problem goes unaddressed, a last option would be for the Fed to cease monetizing the debt, thereby slowing the growth of bank reserves and letting interest rates rise, perhaps substantially. Such an option would mirror the policies of the FOMC in late 1979 under Paul Volcker’s leadership, in which the FOMC restricted the growth in reserves, letting interest rates rise to double-digit levels. Such a policy would significantly disrupt the Treasury market and plunge the economy into a deep recession. Such an action might cause Congress to more aggressively address the debt problem, but it also could quicken the demise of an independent Fed.

Thus, a new accord in which the Fed’s primary mission is price stability that enables maximum employment, and in which the Treasury is responsible for the management of the nation’s debt, is of vital importance. It also is imperative, however, that Congress control the growth of the nation’s debt, and that the deficit be reduced to closer to 3 percent of GDP, a far less burdensome level than it currently carries. Under such an accord, history suggests that the US debt-to-GDP ratio would decline, investment levels would rise, and real economic growth and income would increase.

This quote is from Paul Warburg, one of the architects of the Federal Reserve System, who was referring to the years just prior to the market crash of 1929. While we live in a different era, the warning is timeless. The façade of prosperity can be premised on policies whose consequences sometimes are too long ignored—and deadly. The U.S. economy today is the world’s greatest, but its fiscal and monetary policies are excessive and unsustainable, and because of that, they have placed the nation’s economy on thin ice.

The Dance Continues

For the moment, the economy continues to grow moderately. The year just finished saw better than 2% GDP growth, and for 2026 Congress has provided additional tax incentives and spending intended to assure growth through the year. As a result, the U.S. has experienced a record-breaking stock market, rising asset values and high housing prices, and consumers are taking advantage of these benefits to borrow against rising values and expand consumption.

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Also, while investment in capital goods is mixed, there is strong capital demand for AI investment, projected this year to reach $2 trillion globally and over $500 billion for the United States. The volatility of tariffs has added uncertainty to the economy, but their effects appear to be less significant than originally feared. Finally, the government is deregulating American businesses, thereby promoting innovation. This all suggests continued growth through this year at least.

Underpinning this economic story, however, have been highly stimulative fiscal and monetary policies that carry large risks to the nation as debt levels rise and the Federal Reserve (Fed) prints money to monetize that debt. At the start of this year, a series of tax incentives took effect: tax exemptions on employee tips and overtime pay, reduced taxes for senior citizens, tax deductions for car purchases and tax breaks on capital expenditures, all designed to boost growth. As a result, during 2026, the federal government again will spend over $6 trillion but fund only $4 trillion of that spending out of current revenues.

Complementing this fiscal expansion, and despite rhetoric to the contrary, the Fed restarted its accommodative monetary policy. The real fed funds rate is 1% (the Fed has lowered the nominal rate to near 3.5% while Consumer Price Index inflation is 2.5%.) The neutral, or equilibrium, policy rate is likely above 1% as U.S. productivity gains, returns on capital and corporate demand for capital have likely pushed the equilibrium real rate higher. Accompanying lower interest rates, the Fed has resumed quantitative easing operations, purchasing more than $40 billion per month of new government securities, thereby rapidly expanding its monetary base.

Fiscal Dominance Effect

These policies are designed to run the economy hot. However, while bullish and exciting in the moment, these policies come with risks.

The federal debt has exploded; liquidity demands to fund this debt have increased proportionately. The Fed once again has stepped forward, determined to assure a smoothly functioning, liquid and stable Treasury market. It will succeed in doing so, but at the cost of reallocating resources and undermining its primary mission, price stability.

Much is made of attempts to make the Fed bend to political pressure, but long before its independence became an issue, it had already surrendered much of that independence. For decades the Fed repeatedly intervened in nearly every U.S. money and financial market crisis, providing needed liquidity and making markets temporarily stable. It intervened in markets during the Great Financial Crisis, the pandemic and the 2019 bailout of the highly leveraged government securities market. Unfortunately, in each of these instances, the Fed left emergency measures in place long after the crisis had passed. Its actions reduced market accountability, changed market incentives and promoted speculation.

These actions also have changed incentive for the federal government, which has come to expect the Fed to ensure that the exploding Treasury debt market remains liquid and runs smoothly with low, stable rates. Beyond its mandates regarding price stability and employment, the Fed implicitly is determined to do “whatever it takes” to meet that expectation. The result has been dramatic. Consider, for example, all that happened between 2005 and 2025:

• Nominal GDP increased two and a half times, from less than $13 trillion to over $30 trillion, while real GDP increased one and a half times.

• The CPI index almost doubled.

• The gross federal debt increased nearly 5 times, from $7.9 trillion to $38 trillion.

• The Standard & Poor’s 500 index increased five and a half times, more than the national debt

• In contrast, real weekly earnings, wage and salary, increased only 1.2 times.

These numbers show the effects of voluntary fiscal dominance. If this trend continues, the U.S. will add $2 trillion or more of debt to its balance sheet each year well into future, and the Fed will print the base money to assure funding. For example, it has just committed to buying $40 billion of Treasury debt each month. The party continues, but another crisis is inevitable if the U.S. stays on this path.

Avoiding the Break

Without change, the ice on which the economy rests must break. Kevin Warsh, President Trump’s nominee to chair the Fed, recently proposed establishing a Fed–Treasury policy accord, like that established following World War II, the last time the debt-to-GDP ratio exceeded 100%. At the time, as now, the Treasury wanted the Fed to keep interest rates and the cost of the federal debt low. Inflation was rising, however, and the Fed couldn’t both peg low rates and control inflation. The conflict between the Treasury and the Fed was tense, but ultimately, they reached a compromise in the form of the Fed–Treasury Accord of 1951, which freed the Fed to pursue its price stability objective.

Over the following decade, the U.S. debt-to-GDP ratio fell from 90% to 55%. Fiscal deficits averaged close to 2% of GDP. Fed policy rates averaged to 2.5% and were never higher than 3.5%. The unemployment rate averaged 4.6%. And impressively, inflation remained near 2% while real GDP growth averaged 4%.

Thus, the new Fed chair, working with the Treasury, could establish a new Fed–Treasury Accord of 2026. Under it, the Treasury and the administration, working with Congress, could carefully reduce the deficit from nearly 7% of GDP to 2% or 3%. With less debt to fund, upward pressure on interest rates would ease, allowing the Fed to pursue real price stability, and the Treasury could steadily grow out of the debt dilemma. As history suggests, the nation would enjoy renewed, sustainable economic growth. While the postwar economy was different from today’s, there is no reason that a renewed discipline around fiscal and monetary policy couldn’t provide similar outcomes, before the ice breaks. The U.S. cannot continue its current path, consuming more than it produces and creating and monetizing enormous fiscal and international deficits, without devastating consequences. A new Fed chair and Treasury secretary are well positioned to deliver results. The U.S. is the greatest economic success story in all of history, and if it chooses, it will remain so.

A new accord is needed and will require cooperation from Congress as well as Treasury if the U.S. is to assure price stability, maximum employment, and moderate long-term interest rates. Congress must carefully but steadily reduce its budget deficits and ease the pressure on Treasury to issue ever larger amounts of new debt. If Congress fails to do this, Treasury must respect the Fed’s right not to purchase quantities of Treasury debt beyond levels consistent with price stability (both asset and consumer). Failure to reach such an accord will almost certainly lead to increased market volatility, constant inflation, and slower long-term growth. The first Accord served the Nation well and its lessons should not be ignored if we hope to secure long-term economic success.

By comparing recent proposals to ease capital requirements, improve the communication of examination findings, and clarify regulatory objectives with similar efforts from prior decades, we can better see both the potential gains and risks of deregulation, as well as the importance of proceeding at a deliberate pace.

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Capital Requirements: The First Level of Regulatory Relief

Bank regulatory relief efforts nearly always begin with capital requirements. Banking is fundamentally a leveraged business: the greater the leverage, the more credit available to borrowers and the higher the potential returns to investors. It is therefore not surprising that current policy proposals aim to simplify the most intricate risk-weighted capital frameworks, reduce required bank capital levels, and allow capital to move more freely between insured banks and uninsured affiliate firms.

The goal is to accelerate and facilitate the deployment of capital to productive uses. Congress is also considering proposed legislation that would lower capital requirements for smaller banks in an effort to level the competitive playing field between small and large banks.

Rethinking the Bank Examination Process

Changes to the current bank examination regime are also underway. Regulators are more precisely defining “material findings” related to financial or operational weaknesses identified during on-site examinations, particularly in areas such as liquidity risk management, governance, and risk appetite frameworks. While material findings are meant to address matters of significant risk and consequence, some observers note that excessive procedural requirements have crowded out strategic risk management findings in favor of box-ticking compliance.

The goal is to preserve the discipline that prevents fragility while reducing processes and redundancies that inhibit performance and innovation.

Living Wills and the Limits of Procedural Resolvability

Living wills, or orderly wind-down plans, also feature prominently in the debate over regulatory burden reduction. The Dodd–Frank era vaulted these instruments into the regulatory toolkit as a cornerstone of bank and bank holding company “resolvability.” Yet critics—including academics, think tanks, and regulators themselves—argue that living wills have proven expensive to prepare and are rarely used in crises to execute orderly liquidations. In practice, crisis resolution still falls on government-backed remedies rather than market-driven wind-downs.

As a result, there is growing discussion about rethinking, or even trimming, living will requirements in favor of more credible bank resolution and bankruptcy processes, rather than procedural rituals that are never invoked.

What Past Banking Crises Continue to Teach

Against these reforms, however, it’s crucial to remember the structural lessons of past cycles. The literature on banking crises—bolstered by industry voices and policy analyses—emphasizes a persistent truth: Crises tend to expose policy missteps as much as bank misjudgments. The roots of instability are often macroeconomic and policy-driven and are shaped by inflationary dynamics, monetary policy stances, and fiscal impulses that distort risk perceptions and pricing.

When policy ignites asset price booms and is later followed by somber rate shocks, banks can accumulate portfolios that look resilient on paper, due to opaque asset valuation and related capital calculations, but are fragile in reality. No amount of deregulation can shield banks and the financial industry from these forces. It is the unexpected, no matter the source, that exposes bank weakness and triggers crises.

When Capital and Liquidity Fail Under Stress

From this history and research, a lesson too often ignored is that under sudden stress, institutions that appear to be on solid ground can suddenly fail. Capital foundations reveal themselves to be shallow. Liquidity that once seemed abundant becomes visceral. In crisis after crisis, heavy reliance on liquidity backstops—such as deposit guarantees and bailouts—undermined both market and policy discipline.

The most recent 2023 episode involving several mid-sized and large banks illustrated how a mismatch between perceived safety nets and actual capital and liquidity positions can trigger rapid runs by uninsured depositors when policy shifts abruptly and confidence in the market erodes. Subsequent government interventions, while stabilizing in the short term, underscored the unintended and unwanted socialization of losses and further blurred the line between private risk-taking, accountability, and public protection.

Too Big to Fail and Persistent Market Distortions

The case for simpler, more transparent safeguards is inseparable from concerns about Too Big to Fail. The TBTF dynamic remains a central policy concern: The implicit guarantee that the largest and most interconnected banks will be rescued in a crisis fosters moral hazard, distorts competition, and concentrates systemic risk. TBTF institutions have also been used to justify the extensive regulations imposed on the industry, as an off set to their exemption from the ultimate market test: failure.

Reducing regulatory distortions that shelter TBTF institutions, while preserving robust resolution mechanisms rather than paper exercises, would arguably strengthen market discipline and level the playing field for smaller banks that face disproportionate scrutiny despite posing less systemic risk.

A Prudent Path Forward for Regulatory Reform

So, what might a prudent path forward look like in practice? A balanced approach would pursue targeted regulatory relief while preserving core safety nets and strengthening capital in ways that are both transparent and testable under stress. That balance points to several practical steps:

• Simplify capital standards.

  Move away from overly complex risk-weighted assets toward a stronger, more straightforward leverage metric, supported by credible loss-absorbing buffers and well-calibrated stress-testing. Use targeted risk-based capital overlays only where they demonstrably improve resilience and transparency. The goal is to reduce complexity, improve comparability, and keep the focus on true loss-absorbing capacity. In short: simplify where possible, but do not weaken the spine of capital that underwrites resilience.

• Demand credible resolution capabilities.

  Rather than relying on living wills that have not once been used for crisis response, insist on transparent FDIC resolution procedures for all banks and bankruptcy procedures for bank holding companies. Any reduction in regulatory burden should not undermine the system’s ability to unwind failing firms in an orderly and predictable manner.

• Align liquidity with bank and industry solvency.

  Liquidity runs are driven by fears about solvency. Effective reform should combine meaningful liquidity measures—not brittle rules—with transparent and credible capital standards, ensuring that banks cannot merely rely on backstops to mask underlying liquidity and capital weakness.

• Reduce redundancy, not oversight.

  Streamline regulatory structures by consolidating data within a single agency while ensuring access by all agencies. Apply consistent, cross-cutting standards to bank risk management, governance, and accountability.

• Seek a more market driven and level playing field.

  Propose reforms that curb subsidies and implicit guarantees that distort competition. A more explicit, credible resolution framework, paired with some degree of loss-sharing for uninsured creditors, would help restore market discipline across the banking landscape.

• Ground reforms in economic fundamentals.

  Recognize that macroeconomic policy—fiscal trajectories, inflation, and monetary regimes—shapes risk-taking as much as micro-prudential rules do. The consumer and investor communities respond to policy signals, capital costs, and perceptions of the financial system’s safety, and, thus, the degree of regulatory reform must account for those realities.

Why Deregulation Alone Cannot Deliver Stability

A note of caution should accompany any effort to reduce regulatory burden. Deregulation, while often productive, does not eliminate risk or neutralize policy mistakes. History and academic literature tell us that if carried out carelessly, deregulation, however attractive for efficiency and growth, can lead to larger and more costly crises down the line.

Five decades of banking crises repeatedly show that systemic stability hinges not on predicting every shock but on understanding that market and policy failures create fragility, and stability rests on the industry’s ability to absorb the unexpected. The rolling recessions of the 1980s, the financial and economic crisis of 2008, and the banking panic of 2023 all illustrate the same pattern: Easing regulations and enabling greater risk-taking without reinforcing the industry’s underlying infrastructure—capital, credible resolution, and accountable risk-taking—creates fragility.

Policy accommodation without market and regulatory guardrails may invite a repeat of past cycles that deliver short-term gains often at the cost of higher medium-term losses.

Stability as the Foundation for Sustainable Growth

Finally, the current enthusiasm for regulatory relief presents an opportunity. Bank supervisors have signaled openness to modernizing and streamlining the regulatory framework. Yet the enduring lesson of decades of financial crises remains: The system’s durability rests on a disciplined alignment of capital, credible resolution, and transparent incentives.

Regulating for stability is not anti-growth; it is pro-growth, preserving confidence, channeling capital to productive uses, and avoiding or mitigating the boom-and-bust cycles that hollow out the real economy. As policymakers, practitioners, and observers move forward, their efforts should focus on how reforms will strengthen the market’s infrastructure—not simply repaint its façade.

Looking to 2026, the consensus among private forecasters and international institutions has been adjusted up, showing GDP growth above the 2% mark, often in the 2.2% to 2.6% range. The core growth drivers are threefold: sustained fiscal and monetary policy stimulus in an election year, resilient household demand, and AI investment that keeps business capex elevated even as other investment categories remain unchanged or cool. Finally, regulators will continue their more risk‑tolerant financial framework, with proposals to ease certain bank capital requirements and a shift to streamlined supervision. If realized, these forces will boost credit creation and growth in 2026. However, they also introduce expanded vulnerabilities as the economy’s risk profile and reliance on ever greater leverage behind the growth take their toll on the nation’s credit infrastructure.

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Election-year fiscal stimulus and its demand implications

As 2026 unfolds, political incentives are aligned toward expansionary fiscal measures. Following 2025 legislation, tax relief, rebates, and targeted spending on infrastructure and defense projects are expected to lift aggregate demand in the near term, supporting employment, higher output, and confidence among middle-class households and firms. Historically, incumbents in election years lean away from austerity, and 2026 appears to fit that pattern. The magnitude and composition of this stimulus will be decisive for whether growth accelerates toward the upper end of forecasts or remains more modest.

That said, the Federal Reserve will play a major role in how the impending government spending, large deficits, and debt service costs will be managed forward. Recent history suggests that the Fed will accommodate fiscal policy. It is again engaged in quantitative easing (QE), purchasing $40 billion per month of Treasury debt, under its ample reserves framework, keeping interest rates subdued, an essential ingredient in assuring a favorable growth outlook. The Fed will be under enormous pressure to carry through on its part of the fiscal-monetary policy framework. However, this comes with risks beyond 2026. Should accommodative fiscal and monetary policies be extended too long, they raise the risk of future asset and price inflation, and ultimately the painful tightening of financial conditions as the Fed scrambles to restore price stability. Politics often favors one-off measures to raise near‑term GDP, but the durability of gains will depend on the policy mix and the degree to which higher debt burdens crowd out public and private priorities.

Tariffs, geopolitics, and global demand

Tariffs weighed on some sectors in 2025, but the global demand picture has shifted in ways that cushion the U.S. economy. Across the world, geopolitical pressures have spurred larger defense and infrastructure outlays, heightening demand for high‑tech equipment and capital goods, areas where the U.S. has strong competitive positions. Japan’s late‑2025 defense budget, for example, reflects a broader shift in Asia toward greater preparedness, while European partners have expanded defense and infrastructure spending, and NATO has reaffirmed a strong security commitment. These dynamics support U.S. defense and semiconductor manufacturing, providing a counterweight to tariff-induced drag on imports and exports.

International bodies, the IMF for example, have stressed that tariffs’ direct drag on U.S. output remains but are more modest than originally feared. The Wall Street Journal, quoting the Penn Wharton Budget Model, noted the U.S. effective average worldwide tariff is 10%, while that for China is just above 37%. Also, the rest of the world has been restrained in its response to U.S. tariffs, thus mitigating the hit to world and U.S. growth that was earlier expected. This response on the part of U.S. trading partners, combined with their stepped-up spending in response to global geopolitical events, is persuasive evidence that while trade frictions will persist, they are unlikely to derail the expansion in 2026, though some sector-specific effects will remain.

Middle-class consumption and housing wealth: the leverage channel

A defining feature of 2026 will be household-funded consumption through housing wealth. In recent years housing asset prices have risen sharply and have been especially beneficial to households holding substantial homeowners’ equity. As reported by Meredith Whitney Advisory Group, for example, the average cash-out refinance in recent quarters has been growing at a rate near 6-7%—a signal that households are extracting liquid funds as a cushion against slow income growth and tighter credit conditions elsewhere. The share of refinancings that are cash-out rose meaningfully as homeowners sought liquidity for discretionary purchases and debt consolidation. HELOC activity also remained robust, buoyed by large equity cushions and accessible borrowing baselines in many markets. This leverage channel will help sustain consumer spending even as wage earners struggle with inflation, or when other forms of credit remain comparatively costly. The upshot is a consumer sector that can maintain momentum through 2026 even as a mixed labor market challenges middle and lower-middle income groups.

But the leverage channel also carries risks. Delinquencies in consumer credit have risen in pockets of the market, highlighting that not all households are equally insulated. Should interest rates rise and the economy slow, or if incomes fail to match or exceed inflation and debt service becomes relatively more burdensome, the outlook for consumption and growth could falter quickly.

AI and high-tech investment: A boon to growth

Investment in artificial intelligence and related high‑tech infrastructure remains a bright spot for 2026. Goldman Sachs and other sources, for example, are projecting that global AI spending will approach the $2 trillion threshold, with data centers, GPUs, cloud services, and AI software driving capital outlays. U.S. corporations—led by major technology players—are also expanding their AI capacity and reinvesting earnings into AI-enabled platforms with spending estimates exceeding $500 billion. This not only boosts IT and semiconductor demand but is expected to have effects on productivity and profitability, supporting further investment forward.

IMF analyses also have suggested that AI-driven productivity gains can offset some tariff-related weakness by lifting efficiency and growth in output. Private-sector reporting highlights the wealth effects from rising AI‑led earnings, which can feed further spending through higher asset valuations and increased confidence. While there is concern that AI could impede employment growth, history suggests that over time the gains in productivity and new employment opportunities are worth the transition costs. A more immediate risk is that AI enthusiasm could overshoot fundamentals and eventually lead to a valuation correction.

Deregulation, open markets, and risk-taking

A defining feature of 2025 which is likely to accelerate in 2026 is the embrace of more open, less regulated markets. There has been, for example, an easing of bank capital requirements and a shift toward more streamlined, risk‑based supervision, with some areas permitting self-certification for non-critical compliance. Such changes, if expanded in 2026, will raise banks’ ability to leverage their balance sheet, ease underwriting standards and accelerate credit growth, particularly in mortgages, consumer finance, and higher-risk corporate finance.

This more laissez-faire economic philosophy, while it will accelerate consumption and investment, and help keep credit and economic growth buoyant, comes with its own risks. It will almost certainly raise the risk profile of banks and related capital market institutions. If it leads to less rigorous credit standards, it will raise the probability of mispricing evolving risks. With higher leverage, and eventually greater vulnerability to unanticipated shocks, markets can quickly become unsteady. The most likely path for 2026, therefore, is more credit access, faster growth, and the acceptance of a higher financial risk environment, especially as 2026 progresses.

Growth outlook and medium-term risks

Taken together, the forces described above point to a stronger‑than‑2025 performance in 2026, with forecasters generally placing GDP growth in the mid‑2% territory. IMF and OECD projections hover near 2.0%–2.5%. The composition of growth is likely to be led by resilient consumer spending—underpinned by housing wealth and favorable fiscal signals—and by business investment in AI and IT infrastructure, augmented by government demand from infrastructure and defense initiatives.

But there is a meaningful caveat. The same drivers that push growth forward—elevated leverage, abundant credit, and asset-based wealth effects—also sow the seeds of fragility. Distributional effects are also a critical piece of the story. A possible K-shaped pattern—where asset-rich households prosper while others struggle with stagnant wages and higher borrowing costs—could shape consumption, savings, and financial stability.

The federal government’s debt stack has grown rapidly, and by late 2025 the debt trajectory raised concerns about longer‑term inflationary pressures and tax responses. Corporate leverage has risen in parts of the economy, and delinquencies in consumer credit have crept higher, especially among households with tighter budgets. In other words, the economy in 2026 could be robust in the near term, yet more sensitive to shocks in the years that follow if leverage and financial vulnerabilities intensify.

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It is surprising that the media failed to ask for more detail as to why restarting large open market purchases of U.S. Treasuries was not a restart of quantitative easing (QE), a monetary policy action that perhaps should have required a FOMC vote. The purchase of $40 billion per month of Treasury securities, if it continues through May, as Chairman Powell hinted, would be an annual increase of nearly 7 percent in bank reserves and if continued for all of 2026, would be an increase of 16 percent. Such increases will exceed projected GDP growth over these periods and are a substantial increase in liquidity for the financial system. Such purchases through May would equal 10 percent of the government’s deficit, and if continued through year-end, would equal almost 25 percent.

The Fed indicates that the purpose of these actions is to preclude possible market disruption around tax payment dates, such as April 15, or following large Treasury auctions when Treasury’s general account at the Fed increases and bank reserves decline, reducing market liquidity. However, these are temporary disruptions and can be managed effectively through temporary actions such as the Fed’s discount window or repo operations.

It is a delicate balance for the Fed to choose policy that provides for non-inflationary growth when the government is incurring large and persistent deficits and insisting that interest be kept low. The reopening of QE will, on the margin, increase demand for Treasury debt and suppress short-term rates. If, because of this action, long-term rates rise, the Fed will confront pressure to re-engage in yield curve control by buying long-term Treasuries to keep these rates from rising and slowing the economy. It’s a slippery slope the Fed is traversing, and the outcome is uncertain.

The Fed was designed knowing of the stress that fiscal authorities would place on monetary policy, and over the next year this stress will be acute. The nation’s debt will soon be $40 trillion, the deficit will remain close to $2 trillion, interest on the debt will approach $1 trillion, and all must be funded. At the same time, the demand for capital to meet the needs for AI and other private investment projects will also grow. The Fed will be under enormous pressure to use its ample reserves and administered rate framework to conveniently accommodate all needs. Unfortunately, since resources are limited, the risk to the economy is higher asset and price inflation and the misallocation of resources. The Fed’s most recent action has set the course for next year and beyond, and it is uncertain as to where it will end.

With the onset of the GFC, the Fed’s response, as expected, featured the provision of significant liquidity through large-scale asset purchases (quantitative easing, or QE) and the suppression of short-term interest rates to stimulate the economy. The expectation at the time was that the balance sheet and the FF rate would eventually go back to pre-crisis levels, within an adequate reserves framework.

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However, as the crisis receded, the Fed’s policy stance remained highly expansionary, with several rounds of QE and the suppression of both long- and short-term interest rates. From the mid-2000s to the present, the Fed’s reported total assets have risen from under $1 trillion to about $7 trillion. Its portfolio of Treasuries and government-guaranteed securities has expanded from roughly $740 billion to $4.2 trillion, and reserve liabilities have increased from about $9 billion to approximately $3 trillion. This outsized growth in its balance sheet—initially driven by a policy experiment—has caused the Fed to change its policy framework from an adequate reserves framework to a new ample reserves framework.

Under the ample framework, the Fed maintains a large stock of bank reserves, reducing the need for active balance-sheet adjustment, steering policy primarily through administered rates. Coincidentally, the Fed’s operating toolkit broadened beyond QE to include interest on reserve balances, overnight reverse repos and a standing repo facility. The Fed’s footprint within the nearly $12 trillion repo market has also grown dramatically. This new framework developed as an iterative process without a deep analysis of its long-run efficacy or a comparison of its effectiveness relative to that of the framework it replaced.

In time, fiscal authorities realized that QE, the suppression of interest rates, and the growth in bank reserve balances could be used to facilitate the financing of federal debt under the new ample reserves regime. Today U.S. gross federal debt as a percent of GDP is at a historically high level of 120% and is projected to rise significantly higher over the coming decade. Thus, the Fed’s policy and these emerging trends have brought new challenges to the Fed in balancing its relationships with the Treasury and Congress. First among those challenges is that the Treasury’s funding needs may eventually dominate the Fed’s monetary policy.

Notable recent policy episodes highlight this risk. In September 2019, for example, a decline in bank reserves coincided with a sharp rise in repo rates, reflecting liquidity frictions in Treasury debt balances and market flows. The episode prompted the Fed to renew QE and heightened its resolve to assure an adequate liquid market for Treasury securities. This experience underscores the increasing interdependence of Fed balance-sheet policy, market liquidity, and Treasury funding demands in an environment of high and rising public debt.

In this regard, Dallas Fed President Lorie Logan recently proposed that within the ample reserves regime, the FF rate policy target should be replaced with a tri-party general collateral repo rate target. She correctly noted that FF market activity has diminished relative to the secured-repo markets as the latter has grown in size and importance. She argued that such a change would improve policy transmission and the resilience of the Treasury debt market. However, others have observed that an ample reserves balance sheet could reflect the government’s influence on the Fed to monetize its mounting debt. Consistent with this observation would be for the Fed to suppress its target repo rate to keep government borrowing costs low. Both actions would undermine the Fed’s ability to achieve long-term price stability.

As a comparison, history offers lessons in the usefulness of the adequate reserves framework. Post-WWII, for example, saw the U.S. carry a debt burden like today’s, and the Treasury expected the Fed to manage monetary policy and peg interest rates to keep interest costs low. Although controversial at the time, the Fed defied those expectations and stayed with a disciplined reserve policy, enabling it to focus on price stability while the Treasury managed debt issuance. The late 1970s again demonstrated that a credible, disciplined reserves policy was essential to curbing inflation, as seen under Paul Volcker’s leadership. Such historical periods underscore the importance of disciplined monetary governance that is separate from the Treasury’s debt management in the interest of macroeconomic stability.

While monetary policy can be conducted under either an ample reserve or an adequate reserve regime, the question remains as to which serves the nation’s long-term financial stability best. The policy risks seem high as the Fed embraces an ample-reserves policy framework while the nation’s debt continues its climb. Given these risks, the Fed should undertake a more systematic review of which framework yields the best long-term results. Such a review should include:

• A careful, transparent appraisal to judge whether an ample or an adequate reserve regime would better serve the Fed’s dual mandate in the current debt and liquidity environment.

• A structured analysis comparing costs, benefits, transmission channels and resilience under each regime, with explicit attention to policy signals, transparency and protection against fiscal dominance.

Finally, any framework chosen should include governance safeguards that preserve the Fed’s ability to pursue its inflation and employment mandates, leaving Congress and Treasury responsible for managing the national debt.

Crypto exchanges such as Coinbase currently offer “rewards” on customers’ stablecoin balances, but the banking industry would like to put an end to that. When the loudest voices calling for new restrictions are the incumbents facing competition, skepticism is usually warranted. Still, the question of stablecoin yield is more complicated than a simple fight between banks and crypto. Competitive markets generally benefit consumers, but the implicit guarantees built into our financial system create a moral hazard of privatized profits and socialized losses in the form of bailouts.

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So when crypto firms led by Coinbase launched a lobbying campaign with the catchy URL NoMoreBailouts.org, urging customers to “protect their rights” and “stop big banks from coming after you crypto rewards,” I was intrigued. And while it’s true the big banks may be coming for your crypto rewards, what’s harder to parse are the relative risks stablecoins impose on the financial system as outlined in the GENIUS Act—the law that set the regulatory framework for dollar-backed payment stablecoins in the United States.

As part of the compromise to get GENIUS across the finish line, Congress prohibited stablecoin issuers from paying interest or yield to holders, while remaining silent on distributors such as exchanges and wallets. The “rewards” some platforms advertise typically come not from the issuers themselves but from distributors—by passing through a portion of the income earned on stablecoin reserves, by funding promotions from their own revenue, or through lending and other incentive programs.

At first, it looked like the crypto lobby had outfoxed the banks with this “loophole.” Now, the bank lobby is pressing Congress to close it as debates over the next major piece of crypto legislation, the CLARITY Act, drag on. But the banks’ resistance to stablecoin rewards is just one facet of a much broader question: How do stablecoins fit into the larger monetary system?

The Banking Industry Pushes Back

Banks warn of deposit flight and financial instability if stablecoins start competing with banks on offering yield. They argue that allowing the practice to continue would drain deposits from traditional banks and make credit more expensive. Do banks’ warnings reflect legitimate risks to the financial system or simply their effort to preserve a comfortable status quo? After all, banks benefit from cheap customer deposits, for which they pay little or nothing in interest. Anyone who has checked the rate on their savings account will be sorely aware of this fact.

After digging into the issue, I’m not persuaded by the banks’ case. The banking industry has focused its arguments on the underlying risk that stablecoins present to financial stability as justification for a blanket ban to prevent stablecoins from competing with banks on yield. In a recent article warning about the dangers of allowing stablecoins to compete on yield, the Bank Policy Institute (BPI) begins its analysis with a simple premise: If stablecoins were allowed to pay interest, demand for them would rise—an outcome it treats as inherently risky. Based on a theoretical model, BPI estimates that paying interest could double the projected size of the stablecoin market. That, by itself, is not a policy problem, and policymakers shouldn’t pursue measures to keep growth artificially small. BPI concedes stablecoins may grow large even without yield, but its “macroprudential” push for a blanket ban risks stifling innovation without evidence of harm.

But that’s just the beginning of BPI’s argument. It warns that paying interest on stablecoins would draw funds out of bank deposits, reducing the pool of money banks use to make loans and, in turn, driving up borrowing costs. In other words, consumers choosing Treasury-backed stablecoins over checking accounts could make credit more expensive. That’s certainly possible in theory but hard to project and not obviously a policy failure. The goal of public policy shouldn’t be to shield one industry from competition to keep credit artificially cheap. Banks earn the privilege of holding people’s money by offering the best product in a competitive market, not by entitlement.

Are Stablecoins a Financial Stability Risk?

Perhaps the most formidable objection to allowing stablecoin interest is that stablecoins are a threat to financial stability. Stablecoins share features with their closest traditional-finance cousins—money market funds (MMFs)—that can make balances vulnerable to stress-period redemptions. After Lehman Brothers failed during the Great Financial Crisis (GFC) in 2008, the Reserve Primary Fund—then one of the largest U.S. MMFs—saw its share price fall below one dollar after disclosing exposure to Lehman’s commercial paper, sparking industry-wide withdrawals and prompting Treasury and the Federal Reserve to intervene.

Since then, regulators have overhauled MMF rules to reduce the risk of future runs. During the COVID-19 market panic in March 2020, prime MMFs experienced substantial outflows, prompting the Federal Reserve to once again provide a liquidity backstop. However, government MMFs, which are more analogous to stablecoins under GENIUS, saw no significant outflows and in fact experienced significant inflows as investors fled to safety.

The GENIUS Act’s guardrails for stablecoin reserves go even further than MMF reforms in limiting credit and maturity risk by prohibiting commercial paper and restricting reserves to cash, very short-dated Treasuries with maturities of 93 days or less, Treasury-secured overnight repos, and government-only MMFs. Additionally, reserves must be legally segregated and not rehypothecated by the issuer, with special protections in the event of failure—so holders are better insulated than MMF investors were in 2008. Because a portion of the backing assets can be held as bank deposits, stablecoins aren’t run proof, but they are meaningfully less exposed to credit and maturity risk than pre-GFC MMFs.

Still, the larger, more familiar source of systemic risk remains the traditional, fractional-reserve banking system. Payment stablecoins are designed as a narrower, fully reserved alternative, but issuers still depend on banks to hold money, which leads to another facet of the concerns around financial stability: the run-prone nature and flightiness of the uninsured deposits that stablecoin issuers hold at banks.

Learning from USDC and Silicon Valley Bank

Bank Policy Institute, in response to the “No More Bailouts” campaign, was quick to point out that crypto also benefited from a rescue when Circle, the issuer of USDC stablecoin, had $3.3 billion in uninsured deposits trapped in Silicon Valley Bank when it collapsed in 2023. This caused USDC to briefly de-peg below $1 before regulators stepped in and invoked a systemic risk exception to protect Silicon Valley Bank’s depositors.

The USDC event is both an example of what can go wrong with concentrated deposit risk and a lesson to stablecoin issuers and regulators. Stablecoins can create this type of risk by pooling many small, FDIC-insured deposits into a few large, uninsured deposits at select banks—a problem not unique to stablecoins—but this risk can be mitigated. GENIUS does not directly resolve this risk but does include language instructing the FDIC and NCUA to establish limitations on reserves kept as demand deposits or insured shares at banks and credit unions, to address safety and soundness risks’ at those institutions.

Also, the 2023 banking crisis that ensnared Circle, was during the height of “Operation Chokepoint 2.0,” when policymakers discouraged banks from doing business with the crypto industry. So it’s no surprise that a large share of Circle’s deposits was concentrated in a few regional banks catering to the high-risk tech sector, which was hit particularly hard by the Fed’s 2022 rate hikes. Circle learned its lesson, and today it holds its reserves at one of the Globally Systemically Important Banks, which, for better or worse, would be unlikely to fail during a crisis. The second Trump administration has moved to end debanking based on reputational risk and has signaled that banks are free to serve crypto firms like any other lawful business.

Stablecoins Are Still Small, for Now

Fears that crypto firms will siphon retail deposits from banks remain theoretical—at least until the data say otherwise. As of October 2025, the stablecoin market totals roughly $300 billion—a fraction of the $7.4 trillion held in U.S. money market funds. It’s not obvious consumers will ditch banks en masse anytime soon. According to a CNBC Select and Dynata Banking Behaviors survey, about 57% of American still keep their money in traditional savings accounts over higher-yielding options such as high-yield savings accounts, MMFs, and certificates of deposits.

As a payments technology, stablecoins offer real promise, but given the crypto industry’s reputation as the “world’s largest casino,” exchanges and wallets will likely face an uphill battle for market share—even if they continue to offer rewards. Banks also retain a major competitive advantage: FDIC insurance. If risks from stablecoins getting “too big” materialize, they’re likely years away, not months. Citigroup forecasts stablecoins could reach $1.9 trillion by 2030 in a base case or up to $4 trillion in a bull scenario, through steady adoption in remittances and DeFi. Policymakers still have time to observe real-world data rather than regulate based on hypotheticals.

Managing Stablecoin Demand for Safe Assets

Another systemic concern is that stablecoins would create excess demand for Treasury bills and other short-term government debt. In Without Warning, financial stability scholar Steven Kelly considers that if stablecoin demand for T-bills grows sharply, it could tighten supply and encourage hedge funds and other market participants to “manufacture” synthetic T-bills through basis trades or other short-term funding structures. That pattern—private markets creating near-money substitutes when official safe assets are scarce—has contributed to financial-stability problems in the past.

It’s a legitimate concern, but Treasury is not a passive observer. The supply of T-bills is designed to be elastic, acting as a shock absorber for funding volatility—including surges in private safe-asset demand, as noted by the Treasury Borrowing Advisory Committee. If a spike in stablecoin demand were ever to meaningfully tighten the market for short-term government debt, Treasury could expand bill issuance as part of its normal debt-management process to accommodate stablecoin-related demand—a development the Treasury market is well-equipped to absorb.

And this wouldn’t be the first time a policy change spurred demand for short-term Treasuries. Post-GFC, capital and liquidity rules mandated banks hold more High-Quality Liquid Assets (HQLA), including T-bills, creating sustained policy-driven demand—over the medium to long term—the Treasury successfully met without disrupting markets.

Additionally, the tokenization technology that underpins stablecoins could also alleviate the potential issue of stablecoins absorbing too many HQLAs. Efforts to tokenize collateral—turning Treasuries and repo agreements into real-time, transferable digital instruments—could help liquidity flow more efficiently through the financial system’s pipes. The Commodity Futures Trading Commission recently announced a digital-asset pilot program to test these kinds of experiments, allowing firms to test tokenized Treasury, repo and margin-collateral structures under regulatory supervision. If it works, tokenized collateral could ease the liquidity stresses critics highlight, helping markets clear faster and reducing the need for emergency intervention when volatility hits.

A Better Question: Who Gets Access to the Fed?

The fight over the so-called interest rate loophole distracts from a far more consequential question: Who should get access to the Federal Reserve’s balance sheet and on what terms? While the GENIUS Act establishes tight guardrails to limit risks from stablecoin reliance on the traditional banking system, it leaves the existing framework for Federal Reserve access unchanged.

As IMF economist Manmohan Singh points out, this policy keeps stablecoins on the fiscal side of the system (funded by Treasury bills) rather than the monetary side (funded by reserves), leaving them dependent on commercial banks and other intermediaries. If stablecoins are truly a form of digital money, shouldn’t they eventually have access to the Fed’s balance sheet and be able to hold reserves directly? For now, the Fed has signaled that the answer is no.

The political compromise behind GENIUS carved out a narrow space where stablecoin issuers can function with greater regulatory clarity and demonstrate real-world benefits without promising any broader integration with the monetary system. The law’s passage is a milestone for those who see the potential in blockchain- enabled payments and for privatized forms of money. But if stablecoin technology delivers on its promises, more policy battles are inevitable. The debate ahead will likely center on how digital payment systems fit within the broader monetary framework.

Let the Best Money Win

The fight over the “interest loophole” misses the plot. If banks were genuinely concerned about financial stability, they would urge policymakers to address the harder question: Who should be allowed to access the Fed’s balance sheet, and on what terms? That answer—not another skirmish over yield—is of greater consequence to the the financial system and the dollar. Until policymakers take it up, the least they can do is let people keep earning their stablecoin rewards.

Congress has delegated to the Fed substantial authority to create money and thereby influence interest rates, inflation and economic performance. This delegation and related independence, however, should not mean carte blanche in how the Fed interprets this authority. Without firm boundaries around discretion, Fed policy becomes susceptible to political, financial, labor and corporate influence, which ultimately diminishes its credibility. History provides ample evidence of such outcomes.

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Congress did assign the Fed boundaries, or mandates, to pursue stable prices, maximum employment and moderate long-term interest rates (12 U.S.C. §225a). Over time, however, under the banner of independence, the Fed has broadened its interpretation of these mandates and how best to achieve them. During the Great Financial Crisis (GFC) the Fed began supporting housing credit with its purchases of agency mortgage-backed securities (MBS). It conducted large-scale asset purchases (that is, quantitative easing) and managed the yield curve to provide abundant market liquidity, increase asset values and stimulate aggregate demand. These actions were taken during exigent circumstances and accepted as necessary for financial and economic stability.

As often happens following a crisis, however, these actions and their rationale were woven into the Fed’s ongoing policy framework. In 2010, following the GFC and without congressional approval, the Fed adopted quantitative easing as a principal policy tool and kept the fed funds rate near zero even as the economy recovered. Over a four-year period, the Fed more than doubled its balance sheet as it purchased government and government-guaranteed debt, with too little evidence that the purchases would enhance long-term productivity or real wage growth.

Then, in 2012, the Fed unilaterally defined price stability, not as zero, but as 2% inflation. During and (more significantly) following the pandemic, the Fed funded a majority of newly issued federal debt to facilitate the government’s fiscal expansion. With substantial funding support from the Fed, the national debt increased from about $8 trillion in 2005 to nearly $33 trillion in 2022 while long-term interest rates were kept muted. Today the national debt is approaching $38 trillion. It appears that the Fed has voluntarily subordinated its policy to congressional deficits.

For most of the past two decades, the Fed has repeatedly intervened to assure a smoothly functioning Treasury market and short-term financial calm. In doing so, it has created the expectation that it will do whatever it takes to support these markets and related interest rates, which has made it increasingly difficult for the Fed to say no to political and financial interests. This expectation will only deepen as the national debt accelerates and Treasury looks to the Fed to monetize the debt and suppress interest rates, further subordinating itself to Treasury. Fed independence is under threat, and this threat is difficult to defend for a Fed whose policy is increasingly entangled with fiscal policies.

There is, however, a better path forward. Following World War II, the federal debt also had increased above GDP and was costly to service. Treasury was insisting that the Fed continue to peg interest rates and monetize the debt. At the same time, inflation was rising, and the Fed found itself unable to both serve the Treasury and control inflation, which ultimately led to a clash between institutions.

Finally, in 1951, after tense discussions between the White House/Treasury and the Fed, an agreement was reached that acknowledged their separate duties within the government and the economy. This Accord acknowledged the Fed’s autonomy and recognized that it was not obligated to monetize federal deficits or peg the yield curve, as Treasury had come to expect. The Fed was solely responsible for monetary policy, focused on price stability and long-term employment. In contrast, Congress and the Treasury were responsible for fiscal policy and managing the debt load. This was a pivotal agreement ending years of Treasury-dominated monetary policy.

As important as this agreement was for Fed independence, the more critical outcome was that it confirmed that Congress was responsible for the nation’s debt. Congress and Treasury could not expect printing money to substitute for spending constraints or tax increases in managing the nation’s fiscal program. And what was the result? During the decade following the Accord, the gross federal debt-to-GDP ratio declined from approximately 90% in 1949 to 55% in 1959, and the annual federal deficit-to-GDP stayed below 2%. Real GDP growth averaged just over 4%, CPI inflation averaged 2%, and the unemployment rate averaged 4.6%. Although Fed controlled interest rates increased from their pegged levels, they averaged about 2.5% over the period and at no time exceeded 3.5%. We can only speculate on what the outcome would have been without the Accord, and Congress and Treasury accepting their responsibility to manage the nation’s budget.

Economic conditions are different today, but the lessons of this earlier period still apply. Over the past two decades the Fed has again taken on a greater role in fiscal policy. Under headings such as “the only game in town” and a “smoothly functioning Treasury market,” the Fed turned emergency liquidity facilities into ongoing Treasury accommodation, and if federal deficits continue at their current pace, the Fed will be pressured to continue doing so. Under these conditions, a realistic assessment of the future must include a sharp rise in consumer prices and an explosion in asset prices.

It is time to revitalize the Accord. The Fed should focus on its primary mandate of stable prices and maximum employment. It should stop interpreting the mandate to cover every contingency. Congress and the Treasury should again be responsible and accountable for fiscal policy and address the out-of-control growth in debt. If Congress fails to do so, under the Accord, higher interest rates must follow as the Fed can no longer monetize the debt and suppress interest rates. In contrast, if the debt is managed more responsibly, prices and interest rates will stabilize, business and consumer confidence will rise, and more sustainable economic growth will result. Yes, if the economy experiences acute stress—such as a liquidity crisis or systemic risk—the Fed is empowered to provide temporary liquidity relief, but there should be a hard limit in its duration.

Finally, policy independence, while a core principle of central banking, is of little value if central bankers fail to confine themselves to their mission. There are many challenges that a central bank confronts, but the most challenging is the belief that the Fed can solve all economic problems with the push of its money creating button.

At a recent symposium in Jackson Hole, Wyoming, Fed Chairman Jay Powell outlined many of these forces and their potential effects on the economy. He paid particular attention to the balance between employment and inflation. He acknowledged that unemployment remained low and inflation remained above its target, but he was increasingly concerned that given recent adjustment in the employment numbers, the labor market could quickly weaken, slowing consumption and economic growth. While he also recognized that inflation was above the Fed’s target rate, he appeared to put less emphasis on inflation, concluding that “the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.”

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The Fed is in a difficult spot as the economy seeks a new equilibrium. Powell is right to acknowledge the tradeoffs and risks that the Fed must consider in its policy choices. The case for an interest cut isn’t all that clear, however. With high and rising inflation, an ever-increasing national debt and the public’s fear of inflation, the Fed would be wise to wait until the employment and inflation numbers are reported before the September FOMC meeting before hinting at the FOMC’s next move.

Changing Dynamics

The U.S. for decades has consumed more than it has produced, going from the world’s largest creditor to its largest debtor nation. The current administration is seeking to change this balance and advance the nation’s industrial base and global economic standing. It has imposed higher and more volatile tariffs—taxes—on goods and services imported from U.S. trading partners. It is changing the nation’s fiscal policies to promote industrial growth and assure its financial dominance. Such policies, however, carry their own set of risks and tradeoffs. Tariffs are less efficient than free trade and raise the cost of goods and services. Expanding fiscal policies intended to accelerate economic growth often have the unintended consequences of higher inflation, reduced productivity and slower growth.

Reacting to these dynamic changes is the Fed, with its mandate to assure price stability while also pursuing maximum employment and a stable financial system. In the best of times, this is no easy task. The Fed understands, for example, that tariffs meant to protect domestic productions mean higher prices, often slowing the economy and risking higher unemployment and recession. Such outcomes put pressure on the Fed to lower interest rates to stimulate the economy and maintain maximum employment. Offsetting the new tariffs, however, recently enacted fiscal programs will add stimulus to the economy, and lower interest rates may very well intensify inflation . The timing and net effects of these forces are difficult to anticipate and manage as the U.S. economy seeks balance.

Tariffs and Risk to Growth

U.S. tariffs are higher than they have been in nearly a century, averaging between 15% and 18%, and it’s possible they could go higher still. This supply shock is raising the costs of imports and related goods and services and will tend to slow the economy. The recent strong downward adjustment in jobs data and the more modest declines in industrial production and capacity utilization tend to confirm the tariffs’ slowing effects.

It is also unlikely that the full effects of the tariffs have worked through the economy, leaving it vulnerable to further deterioration, perhaps significantly so. And while inflation remains above the Fed’s target of 2%, and tariffs will keep it elevated, it can be argued that their effect is a one-time shift to a higher price level, not ongoing inflation. Also, current inflation is down significantly from its high in 2022 of 9%. Thus, some economists, including some within the Fed, favor cutting rates now as insurance against an economic slowdown or, worse yet, a recession.

Fiscal Policies and Risk of Inflation

Such reasoning has wide support. However, it discounts the probable effects of recently enacted fiscal policy, which provides new tax cuts and subsidies supporting consumer spending and business investments, both designed to stimulate future growth. And while the jobs number have declined in recent months, the unemployment rate remains low at 4.2%, and average hourly earnings continue to outpace inflation at a rate of close to 1.5%.

Credit markets also appear strong. Although the nation’s debt is a growing concern, the market’s access to capital and credit is readily available and financial conditions are accommodative. Loans at U.S. banks increased at a rate exceeding 2%, second quarter over first of 2025, its fastest pace in 3 years. Equity markets are booming with markets achieving new highs almost daily. Overall, while the risks to economic growth are real, the economy appears strong. Fiscal and credit policies are expansionary and supportive of economic growth.

Interest Rates

It remains for the Fed to thread the needle between the contractionary effects of rising tariffs and the expansionary effects of fiscal policy. Should Fed policy focus on avoiding a possible slowdown in activity, or bringing inflation to the Fed’s self-imposed 2% target?

In judging the appropriate policy rate of interest, the Fed often compares the real fed funds rate (nominal fed funds rate less the inflation rate) to an estimate of the equilibrium natural rate of interest, which is the rate in which the economy experiences neither excessive expansionary nor contractionary pressures. Estimates of this rate, called r*, vary, but estimates provided by institutions such as the International Monetary Fund and Bank for International Settlements suggest it may be within a range of 1% to 2%. The nominal fed funds rate is now 4.3%, and CPI inflation is between 2.7% and 3.0%. Thus, the real fed funds rate is between 1.3% and 1.6%, within the range of the neutral rate, r*.

Also, the demand for capital in the U.S. to fund the growing demand for new technology, and the onshoring of manufacturing activities, appear to be accelerating. This trend, added to the rising national debt, would tend to increase r*. Under these conditions, if the Fed were to lower rates, it would imbed or accelerate the economy’s inflationary impulse, undermining stable prices, maximum employment and ultimately financial stability.

The economy is being pushed in different directions as tariffs are imposed on imported goods, raising costs and slowing the economy, while an expansionary fiscal policy keeps aggregate demand taut and inflation above the 2% target and well above price stability. In balancing the risk tradeoff, lowering interest rates in reaction to the tariffs’ effects while ignoring policies that accelerate aggregate demand will most likely worsen inflation and ultimately undermine economic growth.

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First, I asked David Beckworth—Senior Research Fellow, host of the Macro Musings podcast, and author of the Macroeconomic Policy Nexus newsletter—for his take. He offered the following questions:

Structural Reform

Questions drawn from your 2024 paper with Dan Katz, “Reform the Federal Reserve’s Governance to Deliver Better Monetary Outcomes.”

1. You propose nationalizing Reserve Banks and letting state governors appoint their boards. Why should state politicians, who are also subject to electoral incentives, be trusted more than current directors?

2. You criticize the Fed for “mandate creep” into areas like climate risk, fiscal stimulus advocacy, and racial equity initiatives. Where should the line be drawn between legitimate monetary analysis and inappropriate political engagement?

3. You propose moving bank regulation and crisis-response powers away from the FOMC. How would you structure those functions to remain effective in a fast-moving financial crisis? Would separating monetary policy from supervision risk dangerous blind spots, since supervisory insights often inform rate policy.

Targeting and Operational

4. What do you think about the Fed’s new framework that was introduced at Jackson Hole? The Fed gave up its 2020 framework called Flexible Average Inflation Targeting (FAIT) and has returned to something more like traditional Flexible Inflation Targeting (FIT).

5. If you could start from scratch and wave a magic wand, what would be your preferred monetary policy framework?

6. What type of central bank operating system is ideal in your view: a floor system, a corridor system, or a ceiling system?

7. What would you recommend the Fed do to make the Discount Window and Standing Repo Facility more effective so that they are used as a normal part of business for banks and other financial firms?

8. What type of assets should the Fed be able to buy up in a severe financial crisis?

Fed Independence

9. How do you balance increased accountability and oversight for the Fed with the need for Fed independence to make tough choices?

10. If push comes to shove and fiscal costs are getting prohibitively costly, would you be willing to have the Fed step in to buy up treasury securities and lower interest costs on them? If so, what would be your exit plan to get out of such a situation after fiscal costs get reined in?

11. Do you see the current pressure on the Fed as more of a threat to its legal, political, financial, or economic freedom? See table below for details:

Thomas Hoenig—Distinguished Senior Fellow, former FDIC vice chair, and former president of the Kansas City Fed—would ask the following questions:

1. The FOMC recently updated its monetary policy framework and reestablished its 2% flexible inflation targeting framework. Do you support the updated framework?

2. With inflation now at close to 3%, and unemployment at a relatively low 4.2%, can interest rates be lowered and the 2% inflation target be achieved?

3. The real federal funds interest rate is close to 1.5%. Chairman Powell says this is a "mildly restrictive" rate. Given the current demand and returns on invested capital, and the government's increasing borrowing needs, do you judge this rate to be restrictive? If so, why?

4. Is Fed independence important to achieving price stability, maximum employment, and long-run economic stability?

I also have a few of my own questions:

1. The Fed’s inspector general (IG) is appointed by, and reports to, the Board of Governors—a clear conflict of interest. Would a presidentially appointed, Senate-confirmed IG better ensure impartial oversight and accountability?

2. Should the Fed, as Treasury Secretary Scott Bessent suggests, launch an internal review of its non-monetary operations to ensure that "mission creep" does not jeopardize the independence of its core monetary policy mission?

3. In your 2024 paper with Dan Katz, you argued that the Fed’s governance has fostered “groupthink.” Do you think this still persists, and what changes would you prioritize to fix it?