The Federal Reserve cut rates by 25 basis points yesterday, bringing the fed funds rate to 4.00-4.25%, exactly as markets had expected. Stephen Miran – Trump’s recently appointed member to the FOMC- dissented, preferring 50bp.
Notably, the two other known “doves” on the committee, Christopher Waller and Michelle Bowman, voted with the majority rather than joining Miran’s call for more aggressive easing.
Markets barely moved, with for example the CME FedWatch tool continuing to price another 100-125bp of cuts by September 2026, unchanged from before the announcement. The immediate question isn’t whether the cut was justified. It’s a lot more fundamental: What exactly is the Fed’s nominal anchor?
Looking at the data, it appears the Fed has lost the nominal stability framework that served it well throughout the 2010s.
Without a clear nominal anchor, monetary policy risks becoming increasingly discretionary, politicised, and most dangerously subordinate to fiscal imperatives.
The Decade of Accidental Success
From 2010 to 2019, the United States enjoyed remarkable nominal stability. Few recognised it at the time (I how did – for example in this blog post in 2014) but the data tells a clear story.
Let me explain what we’re looking at. NGDP (Nominal Gross Domestic Product) is the total value of all goods and services produced in the economy, measured in current prices not adjusted for inflation. It’s the sum of real economic growth plus inflation, making it the best measure of total nominal spending in the economy.
PCE (Personal Consumption Expenditures) represents consumer spending, which accounts for roughly 70% of GDP. Since PCE data comes monthly while NGDP is only reported quarterly, I use PCE as a high-frequency proxy for NGDP trends.
The chart above shows an almost perfectly straight line at roughly 4% growth throughout the 2010s. The 3m/3m annualised growth rate fluctuated around its mean of 3.9% within a tight ±1 standard deviation band. This was, whether intentional or not, de facto NGDP level targeting.
The results were precisely what theory would predict. With trend real growth around 2%, that 4% nominal growth path delivered 2% inflation, confirming the basic identity: π ≈ g_NGDP – g_RGDP.
The Fed achieved its inflation target not through complex Phillips Curve calculations, but through stable nominal spending growth.
The Fed never acknowledged targeting NGDP.
They continued to emphasise their dual mandate and inflation target, conducting policy through the lens of unobservable variables like r* and u*. But regardless of the stated framework, the results were clear: stable nominal growth, on-target inflation, and no need for dramatic policy adjustments.
The Real Economy Normalised Quickly—As I Predicted
The COVID shock severely disrupted the real economy in 2020. But real shocks, by their nature, are temporary.
Back in May 2020, when most commentators were predicting a prolonged depression, I wrote on this blog that US unemployment would drop below 6% by November.
The reasoning was straightforward: this was a supply shock, not a demand shock, and market economies recover quickly from supply disruptions when monetary policy maintains nominal stability.
I was right. The labour market recovery was swift, just as economic theory predicted it would be.
By the end of 2021, the real economy had essentially normalised.
The unemployment rate had returned to NAIRU, and the output gap had closed. According to any standard framework (including the Fed’s own models) this is when monetary policy should return to neutral settings. The emergency had passed.
Yet policy remained highly accommodative well beyond this point.
From Deflation Fighter to Inflation Denier
My views on monetary policy rules have remained consistent. I’ve always advocated for rule-based policy targeting nominal stability.
What changed dramatically was my assessment of where the US economy stood relative to that rule.
From 2008 through 2020, I consistently argued that US monetary policy was less expansionary than widely believed – that we were below the optimal nominal path.
I welcomed the Fed’s initial response to the lockdown crisis, fearing a repeat of the 2008-9 deflationary shock.
However, by April 2021, the data forced me to completely reverse my assessment. In a blog post titled “Heading for double-digit US inflation,” I warned that we had swung from being below the optimal nominal path to being dramatically above it.
Using the P-star model and observing the massive growth in broad money supply, I predicted that inflation would surge far above the Fed’s target- potentially reaching double digits.
That forecast proved directionally correct, though inflation peaked at around 9% rather than breaking into double digits. The key insight was recognising that the Fed had allowed a massive ‘liquidity overhang’ to build up, and this would inevitably feed through to prices once the real economy normalised.
The Persistent Nominal Overshoot
Instead of returning to the pre-2020 trend after the real economy normalised, the nominal level shifted permanently upward. The PCE chart above shows this clearly.
Even if we generously re-anchor a new 4% trend from mid-2024, the level remains well above where it should be. This isn’t just about growth rates. It’s about the accumulated overshoot that hasn’t been corrected.
Only in 2025 has nominal growth finally begun to slow toward rates consistent with 2% inflation. But under proper level targeting, this isn’t sufficient.
When you overshoot the level target, you need a period of below-trend growth to return to the path. That’s the “make-up” principle that distinguishes level targeting from growth rate targeting. Instead, the Fed is cutting rates, effectively validating the higher nominal level.
Inflation: Still Closer to 3% Than 2%
The inflation picture confirms this diagnosis:
Since early 2021, core PCE has run persistently above the Fed’s 2% target. Even as it has moderated from its peaks, the trend remains closer to 3% than to 2%. With unemployment still relatively low, this pattern is consistent with excess nominal demand rather than supply disruptions. The supply shock excuse had validity in 2021-22, but not in 2025.
This persistent above-target inflation, combined with low unemployment, indicates that NGDP growth has been too high for too long. The Fed’s 2% target isn’t being achieved because nominal spending growth hasn’t been calibrated to deliver it.
The Elephant in the Room: Fiscal Dominance
What makes yesterday’s cut particularly troubling is the fiscal context. With US public debt-to-GDP above 100% and deficits running close to 6% of GDP, we’re approaching territory where the fiscal theory of the price level (FTPL) becomes relevant.
When markets doubt that future primary surpluses will back current debt levels, the price level must adjust upward regardless of central bank actions.
The Fed appears to have already surrendered to fiscal dominance. Rather than acting as a counterweight to fiscal excess, they’re accommodating it. This isn’t just poor monetary policy; it’s an abdication of institutional responsibility that risks far more than near-term inflation.
The Dollar’s Ticking Clock
Throughout 2025, I’ve warned that we’re witnessing the early stages of a potential challenge to the dollar’s reserve currency status (see here).
This “exorbitant privilege”—which allows the US to finance deficits cheaply and conduct monetary policy with unusual freedom depends entirely on foreign confidence.
As I noted in February when Trump announced his tariff plans, the combination of weaponising trade policy, political pressure on the Fed, and ballooning fiscal deficits creates precisely the conditions that historically have preceded reserve currency transitions.
We saw it with the Dutch guilder giving way to sterling, and sterling eventually ceding to the dollar.
Markets Expect Substantial Further Easing
The CME FedWatch tool shows the modal expectation for September 2026 remains centred around 3.00-3.25%, implying another 100-125bp of cuts from current levels—essentially unchanged from before yesterday’s announcement. Markets assign essentially zero probability to rates being higher than today.
This market pricing suggests the 25bp cut was so thoroughly anticipated that it contained no new information.
The real signal is what this persistent expectation of further easing implies: markets believe the Fed will continue accommodating the elevated nominal level regardless of inflation dynamics. If this occurs alongside continued fiscal deficits and no correction to the nominal overshoot, we could see:
- Long-term yields disconnecting from short rates as term premia explode
- Dollar weakness despite interest rate differentials
- Commodity price surges as investors seek real assets
The Case for NGDP Level Targeting
NGDP level targeting would address all these challenges simultaneously. With a 4% NGDP level target (consistent with 2% inflation given 2% trend real growth), policy would aim to run nominal growth at or slightly below 4% until the level gap closed. This is the systematic “make-up” strategy that level targeting requires – no bygones being bygones.
Moreover, NGDP level targeting elegantly handles supply shocks – a particularly relevant consideration given potential tariff changes ahead.
Under a nominal spending target, relative prices adjust to supply shocks while total spending remains stable. Temporary inflation from tariffs wouldn’t trigger monetary tightening that could cause an unnecessary recession. The central bank would focus on its proper role: providing nominal stability, not trying to offset relative price changes.
As I’ve argued since 2011, the implementation could be straightforward:
- Announce a public NGDP level path
- Use market expectations (potentially NGDP futures) to gauge whether policy is on track
- Adjust policy systematically when expectations deviate from the target path
- No need to estimate unobservable variables like r* or the output gap in real-time
This framework would also provide crucial resistance to fiscal dominance.
With an explicit nominal target, the Fed would have clear justification for tightening when fiscal policy threatens to push nominal spending above the target path. It transforms monetary-fiscal coordination from a political negotiation into a rule-based interaction.
The Risk of Policy Drift
Yesterday’s decision reflects a deeper problem: monetary policy lacks a systematic rule.
Miran’s isolated dissent for 50bp is particularly telling. Here’s Trump’s newest appointee to the FOMC – who co-authored a paper last year calling Fed independence an outdated “shibboleth” and advocating that Fed governors “serve at the will of the U.S. president” standing alone in pushing for even more aggressive easing.
That even the traditional doves Waller and Bowman didn’t join him suggests they recognise some limits to accommodation, but Miran apparently does not.
When each meeting becomes a negotiation rather than a rule-based decision, and when political appointees push for ever-easier policy regardless of economic conditions, the door opens wide to political influence and short-term thinking.
The Fed successfully delivered nominal stability from 2010 to 2019, even without explicitly targeting NGDP. That framework whatever we call it worked. It kept nominal growth stable, delivered on-target inflation, and avoided both deflation and overheating.
Since 2020, that implicit framework has been abandoned. We’ve moved from rule-like behaviour to increasingly discretionary decisions.
The result is persistent above-target inflation, an elevated price level, and markets expecting accommodation regardless of nominal conditions.
Learning from Past Mistakes
My evolving views on this crisis offer a lesson in the importance of nominal anchors. In 2020, I correctly identified this as a supply shock and predicted a rapid labour market recovery. By 2021, I warned about surging inflation when the Fed maintained emergency policies too long. Both predictions stemmed from the same insight: without a clear nominal anchor, policy errors compound.
The Fed had a framework that worked whether they admitted it or not from 2010 to 2019. They delivered stable 4% NGDP growth that translated into on-target inflation.
That framework didn’t require perfect foresight about r* or NAIRU. It’s just a commitment to stable nominal spending growth.
Conclusion: More Than a Missing Anchor
The Fed’s rate cut yesterday reveals multiple layers of institutional failure.
The de facto NGDP stability of the 2010s has given way to discretionary policy that validates whatever nominal path emerges from fiscal and political pressures.
The US is facing not just above-target inflation and an elevated price level, but potentially epochal challenges: fiscal dominance overtaking monetary independence, and the gradual erosion of dollar hegemony. These aren’t distant risks. They are unfolding now, hidden in plain sight behind market complacency.
The solution remains straightforward: commit to a nominal level target and stick to it. But yesterday’s cut suggests the Fed lacks either the understanding or the courage to do so. The anchor isn’t just drifting. It may already be lost. And with it, potentially, goes American monetary exceptionalism.
Looking back at my predictions from 2020 and 2021, the lesson is clear: get the nominal anchor right, and the real economy largely takes care of itself. Get it wrong, and you don’t just get inflation or recession. You risk the entire monetary architecture that has underpinned American prosperity for generations.
The coming months will be critical. If the Fed continues down the path markets expect another 100-125bp of cuts by this time next year – without addressing the nominal overshoot, we’ll know the answer: there is no anchor, only drift.
And a final warning: Once the markets realise that the nominal anchor is broken the Treasury bond yields might explode.
