On Friday, Aug. 22, Federal Reserve Chairman Jerome Powell delivered his annual speech at the Kansas City Fed’s 2025 meeting in Jackson Hole, Wyoming. He said the balance of economic risks “may warrant” an adjustment in policy stance. Stocks surged, and the market immediately raised the odds of a 25-basis-point cut in the federal funds rate on Sept. 17.

Sources: Federal Reserve Board, Haver Analytics, First Trust

The Jackson Hole central banker confab always has a theme, and this year’s was “Labor Markets in Transition.” What stands out to us is that the Fed seems to believe its only real tool right now is short-term interest rates, specifically the federal funds rate.

If you listened to Powell’s speech (transcript here), that’s essentially all he discussed. Well, almost. He also touched on tariffs, supply chains during the pandemic, immigration, and a few other issues far outside the Fed’s responsibility. He mentioned them only because they could influence the Fed’s decisions on short-term rates.

What the Fed doesn’t talk about is the money supply or the size of its balance sheet. At Jackson Hole, it didn’t respond to senators who think paying private banks roughly $200 billion a year to hold reserves and losing $100 billion per year is reason for concern. The Fed just ignores these questions.

Apparently, the Fed thinks changing short-term interest rates can affect nearly anything the economy throws its way. We won’t argue that the federal funds rate is one of the most important financial market indicators in the world. But is it really the single biggest driver of economic activity?

Consider recent history:

• The Fed held interest rates near zero for seven years after 2008. The U.S. did not experience inflation, and real economic growth remained relatively sluggish.
• It kept interest rates near zero for two years during COVID. This time, we ended up with 9% inflation, and real growth remained slow.

So maybe short-term interest rates are not quite as economically impactful as the Fed thinks they are. Notably, the money supply barely budged after 2008 but soared during COVID. If it were up to us, we’d factor money supply into the analysis. The Fed doesn’t.

That brings us to Powell’s real announcement: The Fed is changing its “framework” for managing monetary policy. In 2020, Powell and the Fed decided that inflation should “average” 2% over time. For some reason, the fact that inflation had been about 1.5% per year over the previous 10 years bothered the Fed.

We would call keeping inflation below 2% a victory, but the Fed viewed this low inflation rate as an impediment to growth. So, to raise the “average rate” to 2%, it could run inflation above that for some unknown time and by some unknown amount in future years to “make up” for the lower inflation. The result: the highest inflation rate in 40 years and more volatility in long-term interest rates.

Now, until it decides to change again, the new framework will target 2% inflation. No more averaging. At the same time, the Fed decided it will not worry as much when the labor market runs hotter than full employment.

All of this sounds like an excuse to cut rates. What we really want is an explanation for why the Fed decided to increase the size of its balance sheet from $800 billion to $6.6 trillion—a more than sevenfold increase. We also want to know why it allowed the money supply to nearly triple between 2008 and 2025. And, finally, we want to know why it thinks hundreds of billions of dollars in bank losses are acceptable today but weren’t in 2008.

The 2008 change in monetary policy was one of the biggest changes in U.S. history, yet the Fed behaves as if it never happened. By flooding the system with reserves, the Fed removed daily trading by market entities in the federal funds marketplace. The Fed “administers” the rate. We call it price-fixing. Reporters don’t ask about it. Central banks around the world have now become money-losing hedge funds and continue to operate as though nothing has changed.

Editor’s note: Brian Wesbury is chief economist at First Trust Advisors LP. He and his team prepare a weekly market commentary titled “Monday Morning Outlook,” as well as frequent research reports and the recurring feature “Three on Thursday.” Proactive Advisor Magazine thanks First Trust for permission to republish an edited version of these commentaries. This article was first published on Aug. 25, 2025.

This report was prepared by First Trust Advisors LP and reflects the current opinion of the authors. It is based on sources and data believed to be accurate and reliable. Opinions and forward-looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

The opinions expressed in this article are those of the author and the sources cited and do not necessarily represent the views of Proactive Advisor Magazine. This material is presented for educational purposes only.