Help is on the way at the Fed, researcher predicts

Federal Reserve Policy, Deregulation & Economic Outlook

Key Concepts:

• Federal Reserve (The Fed): The central banking system of the United States, responsible for monetary policy.
• Rate Cuts/Rate Hikes: Adjustments to the federal funds rate, influencing borrowing costs and economic activity.
• Inflation: A general increase in prices and a fall in the purchasing value of money.
• Deregulation: The removal of government regulations, intended to promote economic growth.
• Fiscal Policy: Government spending and taxation policies.
• Monetary Policy: Actions undertaken by a central bank to manipulate the money supply and credit conditions.
• Supply-Side Economics: Economic theory advocating for tax cuts and deregulation to stimulate production.
• Phillips Curve: An economic concept claiming an inverse relationship between inflation and unemployment.
• Keynesian Economics: Economic theory advocating for government intervention to stabilize the economy.
• 100% Expensing: Allowing businesses to immediately deduct the full cost of certain investments.
• Endangerment Clause: A provision within the Clean Air Act used by the EPA to regulate greenhouse gas emissions.

I. Current Fed Stance & Anticipated Changes

The discussion centers around recent Federal Reserve minutes revealing limited appetite for interest rate cuts, with some members even considering rate increases. Dan Clifton argues this stance will likely shift with a new Fed Chairman, specifically referencing Kevin Warsh. He believes current regional Fed presidents, influenced by the perceived inflationary impact of tariffs, are hindering rate cuts. Clifton anticipates a potential single rate cut before the new Chairman’s arrival, followed by more aggressive cuts once Warsh assumes leadership. He highlights the impact of recent fiscal policies – particularly 100% expensing for businesses and consumer tax refunds (up over 20% year-over-year) – as providing “time” before rate cuts become necessary. He asserts the Fed has been consistently “wrong” in its assessments.

II. The Limitations of Fed Economic Models

Larry Kudlow emphasizes a critical flaw in the Fed’s economic modeling: its inability to account for the impact of deregulation. He points out the Fed consistently predicts economic growth of around 1.7%, significantly lower than the current 4% (and potentially higher) growth rate. Kudlow argues that the Trump administration’s deregulation efforts, potentially worth $2 trillion, are a major driver of economic growth but are entirely absent from the Fed’s models. He specifically mentions the EPA deregulation and the impact of revising the Endangerment Clause.

Michael Faulkender corroborates this, noting the success of deregulation during Trump’s first term – growth without inflation – contrasted with the high inflation experienced under the Biden administration following increased regulation. He stresses the Fed models fail to capture these effects.

III. Regional Fed Presidents & Leadership Concerns

Faulkender expresses concern about the composition of the regional Fed presidents, specifically citing Austin Goolsbee (Chicago Fed President, formerly Obama’s CEA Chairman) as a voice advocating for the inflationary impact of tariffs and dismissing the benefits of deregulation. He criticizes the unanimous decision to renew the terms of existing Fed presidents for another five years, suggesting Kevin Warsh should reassess these appointments.

IV. Supply-Side Economics & Inflation Control

Kudlow and Clifton both champion supply-side economics, arguing that tax cuts and deregulation reduce inflation by increasing the supply of goods and services. Kudlow states, “Supply-side tax cuts create more goods. If the money supply is stable, that’s going to lower prices.” Deregulation is presented as a key inflation fighter. They both lament the Fed’s lack of models to incorporate these supply-side effects.

V. Upcoming Financial Deregulation & Capital Unlocking

Clifton highlights an impending financial deregulation initiative led by Vice Chairman Bowman, expected to unlock “hundreds of billions of dollars of capital” and improve capital allocation for lending, job creation, and investment. He reiterates the Fed’s inability to model the impact of this deregulation, emphasizing the need for leadership change. He believes the data will ultimately force the Fed to acknowledge the positive effects of deregulation, leading to a shift away from outdated Keynesian and Phillips Curve models.

VI. Optimistic Economic Projections for 2026

Kudlow presents a highly optimistic economic forecast for 2026, predicting potential 5% GDP growth and a CPI below 1%. He attributes this to the combined effects of deregulation, tax reform, reduced government spending, and American energy dominance. He also anticipates further declines in gasoline prices once the “Iranian war is settled” by the President, noting the pervasive impact of energy prices on the economy.

VII. The Importance of Productivity & Model Updates

Faulkender concludes by emphasizing the importance of productivity improvements, driven by deregulation, tax reform, and unleashing American energy. He argues the Fed should focus on modeling productivity gains, particularly those stemming from AI and energy advancements, rather than relying on outdated models that underestimate the economy’s potential. He believes Warsh can initiate the necessary model modifications to accurately reflect the economy’s capabilities.

Notable Quotes:

• Dan Clifton: “The Fed continues to be wrong, but help is on the way because Kevin Warsh…”
• Larry Kudlow: “There’s no model in the Fed for supply-side tax cuts either. There’s no model for 100% depreciation.”
• Michael Faulkender: “When you have the combination of deregulation, tax reform, cutting wasteful government spending and unleashing American energy dominance, those are the ingredients that you need to bring out productivity.”

Logical Connections:

The conversation flows logically from an assessment of the current Fed policy (resistance to rate cuts) to a critique of the Fed’s economic models (failure to account for deregulation and supply-side effects). This critique then leads to a discussion of leadership concerns within the Fed and the potential for change with a new Chairman. The optimistic economic projections for 2026 serve as a culmination of the arguments presented, demonstrating the potential benefits of the policies advocated by Kudlow and Clifton.

Data & Statistics:

• Consumer tax refunds are up over 20% year-over-year.
• Current economic growth is around 4%, while the Fed models predict 1.7%.
• Potential deregulation benefits estimated at $2 trillion.
• Optimistic 2026 forecast: 5% GDP growth and CPI below 1%.

Conclusion:

The discussion paints a picture of a Federal Reserve hampered by outdated economic models and resistant leadership. The speakers advocate for a shift towards supply-side economics, emphasizing the positive impacts of deregulation and tax cuts on economic growth and inflation. They express optimism that a new Fed Chairman, Kevin Warsh, can initiate necessary changes to the Fed’s models and policies, unlocking the full potential of the American economy and achieving sustained growth with low inflation. The core argument is that the Fed is currently misinterpreting economic signals due to its flawed modeling and needs a leadership overhaul to adapt to the realities of a deregulated, supply-side driven economy.