A Whole Lot of Fed and a Little Bit of Bitcoin

Strengthening U.S. monetary policy, from Jackson Hole to the blockchain.

Dear readers, next week is a big one for Fed watchers. Fed Chair Jerome Powell is expected to finally unveil what the Fed plans to do with its Flexible Average Inflation Targeting (FAIT) framework at the Jackson Hole Symposium. We will use this occasion as an opportunity to revisit the fate of FAIT once more, as well as two other reforms the Fed sorely needs: the overhaul of its operating system and the recapitalization its balance sheet. And to top it all off, we will take a fun detour at the end into Bitcoin, with highlights from my podcast recording at the Bitcoin Policy Institute’s 2025 Summit. But first, let’s set the stage for that big reveal at Jackson Hole and what it could mean for the Fed’s policy framework going forward.

It’s the Final Countdown to the Big Framework Reveal!

One of the most important gatherings of central bank leaders from around the world will take place next week in Grand Teton National Park in Jackson, Wyoming. It is an invitation-only event and the venue where the Fed Chair often delivers speeches that shape the future direction of U.S. monetary policy. Back in 2020, Chair Powell used this stage to unveil the Fed’s Flexible Average Inflation Targeting (FAIT) framework to much fanfare. Now, he is widely expected to announce its official end and outline what will replace it. This is a big deal for reasons I have discussed before, but suffice it to say, it will have a far more lasting impact than the latest hints about the path of interest rates gleaned from the conference.

Listeners of the podcast and readers of this newsletter know that the framework review has been near and dear to my heart. While I would love to see the Fed fully embrace an NGDP level target, Chair Powell and the FOMC have signaled that they will instead adopt some form of Flexible Inflation Targeting (FIT). Given this likely path, I have been urging the FOMC to design its FIT framework so that it is anchored to a stable growth path for NGDP. Such an approach would allow the Fed to look through temporary supply shocks while still anchoring medium-run inflation expectations.

In fact, by stabilizing the growth path of NGDP, the Fed would, in effect, secure a medium-run inflation target as well and get a “two-for-one” targeting deal. I discuss this very point here in this recent hallway musings at my office:

This two-for-one deal could be achieved within a FIT regime by including language in the consensus statement that explicitly ties the framework to a stable NGDP growth path. Here is one way the FOMC could word the new consensus statement along these lines. Here’s hoping we see something like it next week!

Improving the Fed’s Operating System

Another important reform the Fed should be thinking about is how to improve its operating system. This question is also one of my hobby horses, as regular readers and listeners will know from my many podcasts and newsletters on it. At present, the Fed uses a floor operating system. I would like to see it shift to a demand-driven ceiling system, which would reduce the Fed’s footprint in financial markets, keep liquidity latently ample, and eliminate the duration mismatch on the Fed’s balance sheet. Here is a brief summary of the three main options for a central bank’s operating system:

For the Fed to move from a floor system to a ceiling system, it would have to clear some big hurdles: shrinking its balance sheet, making the Discount Window and Standing Repo Facility more effective, and taming the wild swings in its balance sheet caused by large inflows and outflows from the Treasury General Account (TGA) on the Fed’s balance sheet.

The TGA is the government’s checking account at the Fed, and when its balance swings wildly—as it often does—it can spill over into interest rates and money markets, forcing the Fed to scramble to keep policy on track. Two recent proposals—one from Annette Vissing-Jorgensen, the other from Bill Nelson—offer fixes for the TGA volatility.

Annette Vissing-Jorgensen’s fix is to “back” the TGA entirely with short-term Treasury bills. The Fed would hold bills equal to the TGA balance and adjust the holdings as the TGA changes—buying bills when the TGA rises, letting them mature or selling when it falls. This “segregates” the TGA from the rest of the Fed’s balance sheet, keeping reserves steady and interest rates stable, without touching longer-term assets. It is also easy to explain: the Fed’s banking role for the government stays separate from monetary policy. Implementing it would mean shifting about $600 billion from notes and bonds into bills over one to two years.

Bill Nelson’s alternative is to invest the TGA in the repo market, via reverse repos from the Fed’s perspective. When the TGA rises, the Fed would lend that cash into the repo market, offsetting reserve losses and injecting repo financing just as private supply tightens. When the TGA falls, the Fed’s repo lending would shrink in step. This approach avoids large portfolio shifts, instead using market operations to neutralize TGA swings while stabilizing repo markets. These two solutions are summarized below:

So why do these two solutions matter? Because either approach would effectively stabilize the TGA’s impact on reserves, removing one of the main operational justifications for the Fed’s current floor operating framework. Today, big TGA swings are one reason the Fed maintains an abundant supply of bank reserves, ensuring that even large Treasury cash movements don’t push short-term rates around. If the TGA were managed through either a T-bill backing strategy or automatic repo investments, those swings would be neutralized at the source. That would make it easier for the Fed to consider operating with leaner reserve balances in the future, potentially opening the door to a different framework for implementing monetary policy.

Two Ideas for Recapitalizing the Fed’s Balance Sheet

A final area for reform is finding a way to recapitalize the Fed’s balance sheet. I want to briefly share two ideas for doing so and restoring a positive net cash flow to the Fed. The first idea, from Peter Stella, builds on a concept I covered in a previous post about shrinking the Fed’s balance sheet with minimal disruptions. It works like this:

First, the U.S. Treasury would issue additional short-term T-bills and swap them for the longterm Treasury bonds currently held by the Fed. Since these new T-bills would not fund budget deficits, they would not count against the debt ceiling. Second, once the Fed holds the new T-bills, it could gradually sell them into the market, exchanging reserves for T-bills in a way that drains excess liquidity without dumping longterm Treasuries into the market and triggering financial instability. Drawing on his experience at the IMF advising central banks in similar situations, Peter aptly calls this approach “exiting well.”

This proposal has the added advantage of eliminating the Fed’s current balance sheet losses by aligning the duration of its assets with that of its liabilities. In other words, both sides of the balance sheet would be short-term and carry similar interest rates, ending the losses on bank reserve liabilities while still allowing the Fed to earn profits on its currency liabilities. This would also end the unrealized market losses on the Fed’s balance sheet.

The second idea comes from Paul Kupiec of AEI. He argues that the Federal Reserve could shore up its depleted capital by tapping provisions already in the Federal Reserve Act, provisions that have never been used. Member banks of the Federal Reserve System are required by law to buy stock in their regional Fed bank equal to 6% of their own capital and surplus, but they only pay in half of that amount. The other half is “callable capital” that the Fed can demand if needed to cover losses. Kupiec notes that the Fed could, right now, call in that unpaid 3% and potentially even invoke the full double-liability authority, raising tens of billions of dollars in fresh capital.

He also points out that the Fed is still paying dividends to member banks, borrowing to do so, even while running deep losses. Ending those dividend payments, at least temporarily, would conserve cash and reduce the scale of recapitalization needed. While neither the call-in of bank capital nor the suspension of dividends would fully erase the Fed’s capital hole, they would force the private banking sector—which legally owns the regional Fed banks—to share in the costs, rather than leaving them entirely with the taxpayer.

Kupiec’s bottom line: the law already gives the Fed tools to recapitalize itself without leaning on the Treasury, but so far, those tools have remained on the shelf. Here is short video clip of Paul and I discussing these points.

A Little Bit of Bitcoin

Finally, let’s shift gears and talk Bitcoin. This week’s podcast features Will Luther and Josh Hendrickson for a wide-ranging conversation on the evolving role of Bitcoin in global finance. We examined why policymakers should take Bitcoin seriously—not merely as a speculative asset, but as a potential hedge against future challenges to the dollar’s reserve status, a signal of U.S. support for neutral reserve assets, and even a tool to maintain geopolitical influence in a changing payments landscape. Will and Josh also addressed George Selgin’s critiques of the strategic Bitcoin reserve proposal, arguing that Bitcoin could function as a low-cost “insurance policy” against an uncertain monetary future and that U.S. accumulation today could both capture long-run gains and shape adoption patterns abroad.

We also explored Bitcoin’s outlook and scalability concerns, tackling common criticisms about volatility and use as a medium of exchange. The guests argued that as adoption broadens, financial products proliferate, and close substitutes develop, Bitcoin’s volatility is likely to decline, potentially enabling wider transactional use, especially in countries with unstable currencies. They discussed the emergence of Bitcoin treasury companies like MicroStrategy as examples of regulatory arbitrage meeting unmet institutional demand, and how Bitcoin’s growth to date has already exceeded the early expectations of both proponents and skeptics. While the future size of Bitcoin’s role remains uncertain, Luther and Hendrickson emphasized that it is already far too significant, and evolving far too quickly, to ignore.

The show and its full transcript can be found here. Here is some bonus content from our conversation that did not make it on to the podcast.