Willem Buiter consider the US central Bank's failings in light of recent criticism from the US secretary of the Treasury

By Willem H. Buiter

In recent commentaries published by the Wall Street Journal and The International Economy, US Secretary of the Treasury Scott Bessent criticized the US Federal Reserve’s new “gain-of-function” monetary policy, particularly the use of large-scale asset purchases when the policy rate was at the effective lower bound (ELB). By straying from its narrow statutory mandate, he suggests, the Fed put its own independence at risk.

While most observers would say that the Fed has a dual mandate (price stability and maximum employment), Bessent quite rightly refers to “moderate long-term interest rates” as well. Moreover, the Fed also must ensure financial stability – its most important function. Owing to its unique ability to issue monetary liabilities, it is the natural lender of last resort (LOLR) when domestic-currency loans are necessary to prevent default and insolvency of systemically important banks and other financial institutions.

Like any central bank, the Fed is also the natural market maker of last resort (MMLR), purchasing systemically important financial instruments when their markets have become or threaten to become illiquid, disorderly, and dysfunctional. But Bessent does not explicitly acknowledge this function, and in any case, such asset purchases, like LOLR loans, should be reversed when liquidity and orderly financial market conditions have been restored. The Fed should not intervene unless it must.

Bessent agrees that the Fed legitimately engaged in LOLR activities and other financial rescue operations for banks and non-bank financial intermediaries during the 2008-09 financial crisis. But from 2010, with the short-term policy rate at or near the ELB, the Fed tried to boost economic growth and inflation through continued quantitative easing (QE) – large-scale purchases of public and private assets – and Bessent considers this policy to have been ineffective.

In March 2020, the Fed started its fourth round of QE in response to the COVID-19 shock, while President Donald Trump, followed by Joe Biden, pushed through large fiscal stimulus packages. During this period, the Fed’s large-scale asset purchases did boost asset prices – real and financial, including government debt and mortgage-backed securities (MBS). But such large-scale asset purchases are nonetheless objectionable. Most of them could not be justified as necessary for stabilizing systemically important financial markets or as an appropriate monetization of public debt that had been issued to fund a fiscal stimulus.

Worse, large-scale central-bank purchases of (relatively) low-risk financial assets drive private-sector investors into higher-risk assets, potentially inflating dangerous bubbles. Consider the situation today. The Shiller PE (price/earnings) ratio for the S&P 500 on October 9, 2025, was 39.09 – a valuation that makes sense only if the US experiences a sustained economy-wide AI growth and profits miracle.

Could the Fed’s “moderate long-term interest rates” objective justify purchases of mostly long-duration public and private assets when systemically important financial markets are not disorderly or illiquid, but are judged by the central bank (and other supposed experts) to be immoderately high? Recall that, from November 2008 until March 2010, the Fed already purchased $175 billion of agency debt, $1.25 trillion of mortgage-backed securities (MBS), and $300 billion of long-term US Treasury debt, even though long-term yields were too low after March 2009 – and indeed for most of the period between the financial crisis and the pandemic.

The Fed and most other G7 central banks have made numerous policy errors this century. They were surprised by the global financial crisis, which was made longer and more severe by insufficiently restrictive monetary policy and lax regulation and supervision (including the failure to extend appropriate rules, regulation, and supervision to the growing non-bank financial sector). Moreover, central-bank balance-sheet expansions that were excessive in size and duration have contributed to the financial bubble that is currently underway. And monetary policymakers failed to anticipate fully the inflationary surge following the pandemic, Russia’s invasion of Ukraine, and the massive fiscal and monetary stimuli that were marshaled in response.

Sudden balance-sheet expansions that might have been cyclically appropriate at first, such as LOLR operations, soon became excessive. Central banks failed to provide emergency liquidity at appropriate interest rates – thus encouraging moral hazard, future reckless lending, and risky investment behavior by the LOLR beneficiaries.

Equally, since the 2023 defaults of Silicon Valley Bank, Signature Bank, and First Republic Bank, it has been obvious that the Fed’s microprudential regulation and supervisory role must be rethought. The Fed is the natural primary macroprudential regulator and supervisor, but it should always consult the other members of the Financial Stability Oversight Council. It should be a minority member of the decision-making bodies for microprudential regulation, with a remit spanning banks (including savings banks) and non-bank financial intermediaries, both conventional and digital, including blockchain-based entities and issuers of stablecoins and other crypto assets.

When it comes to stimulating the real economy, tax cuts and (well-designed) deregulation certainly will provide additional aggregate demand. But, unlike Bessent, I do not doubt that public spending (especially on infrastructure) will boost real economic activity meaningfully. I also think US monetary arrangements (and those of all other currency areas) would be well served by measures to reduce the temptation of QE and other massive central-bank balance-sheet expansions. I would eliminate the ELB by abolishing coin and paper currency and introducing an interest-bearing retail central-bank digital currency, permitting both online and offline transactions, and without caps on account size or transactions. These could then pay deeply negative interest rates, if fulfilling the Fed’s triple monetary-policy mandate made this necessary.

But I doubt that Bessent would favor these proposals to abolish government coins and currency. After all, Trump is planning to issue a coin with his face on it to mark the 250th anniversary of the Declaration of Independence next year. Fortunately, Bessent does emphatically support the Fed’s operational independence, which itself is consistent with cooperation between monetary and fiscal policymakers. For the best results, fiscal authorities should simply refrain from trying to force the central bank to engage in actions that violate its policy mandates.

Willem H. Buiter, a former chief economist at Citibank and former member of the Monetary Policy Committee of the Bank of England, is an independent economic adviser. Copyright: Project Syndicate, 2025. www.project-syndicate.org