Windfall taxes - analysis

Labour’s call for a windfall tax on North Sea oil and gas follows in Thatcher’s footsteps

The call has gone up to raid oil and gas profits as crude prices soar and the cost-of-living crisis bites. But would it do more harm than good, asks Jon Yeomans

Jon Yeomans

Sunday February 13 2022, 12.01am, The Sunday Times

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Bernard Looney was feeling confident. After a bumpy couple of years for BP, he had some good news to impart. Oil prices had rebounded from their Covid-induced lows and money was pouring back into its coffers. Presenting BP’s fulsome third-quarter results last November, the chief executive remarked that it was “literally a cash machine”.

Looney may wish he had been more circumspect. The throwaway comment has become a stick with which to beat the industry, emblematic of oil producers making out like bandits while ordinary people suffer. Global gas prices are soaring and millions of households face the prospect of bills rocketing from April, when the energy price cap goes up.

On the same day that industry regulator Ofgem announced that the cap would rise by £693 a year to just shy of £2,000, Shell said it would buy back $8.5 billion (£6.25 billion) of its own shares and raise its dividend. The optics, as they say, were not good. Now oil is heading towards $100 a barrel and the Labour Party is calling for a windfall tax on oil majors to keep down energy bills. “North Sea oil and gas producers who have made a fortune... should be asked to contribute,” said Ed Miliband, the shadow climate secretary.

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Calls for a fresh levy may play well with an electorate crying out for relief from the cost-of-living crisis. And it would not be the first time the UK has slapped a windfall tax on a big industry — even if such measures have been used sparingly in the past. But chancellor Rishi Sunak has indicated his aversion to the idea; after all, he needs to burnish some low-tax credentials with his Conservative backbenchers. In truth, the Tories are no strangers to a tax raid, yet the question remains: would a windfall tax on the oil and gas giants be an effective or desirable tactic at a time of national turmoil?

The key definition of a windfall tax is that it should be a one-off. It typically targets an “unearned windfall that has occurred to somebody not as a result of their own actions”, said Chris Sanger, head of tax at the accountancy firm EY.

Oil and gas companies have seen no change in their costs but a very big increase in the price of their products — “for reasons outside their control”, added George Dibb, head of the Centre for Economic Justice at the IPPR think tank. BP’s windfall was unexpected — because of very high gas prices.

Moral maze

There is also a moral dimension to a windfall tax. Dibb believes a line can be drawn between large oil and gas profits “and the fact that wide numbers of the general public are facing quite severe economic hardship” because of those same prices. “That is a fundamental injustice within our economy and it can be remedied with a relatively small tax,” Dibb said.

North Sea oil and gas companies already pay a surcharge on top of corporation tax, bringing their tax rate to 40 per cent; Labour’s proposal is to lift this to 50 per cent, raising about £1.2 billion. It would use this, along with a couple of other measures, to cut VAT on energy and expand the Warm Homes Discount, lowering bills for 9 million households most in need.

Unsurprisingly, the sector is opposed to a fresh tax, pointing out that surging gas prices mean that the Treasury will still rake in £3 billion in extra tax revenue if it leaves rates alone. A windfall tax would “send financial shockwaves through the industry”, trade body Oil & Gas UK (OGUK) warned; it would discourage firms from investing in North Sea gas and make Britain more dependent on imports.

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However, there is a precedent for a moralistic windfall tax, and it comes from Margaret Thatcher’s first government. In 1981, then-chancellor Geoffrey Howe imposed a 2.5 per cent levy on bank deposits to raise about £400m from the giant profits banks were making through interest rates as high as 15 per cent. At the time, millions were struggling through recession and high unemployment. Thatcher recalled: “Naturally, the banks strongly opposed this. But the fact remained that they had made their large profits as a result of our policy of high interest rates, rather than because of increased efficiency or better service.”

Labour also imposed a windfall tax in 1997 on a string of privatised companies such as British Airways and British Gas — sell-offs that were deemed to have been priced too cheaply and to have left the businesses too loosely regulated, allowing them to bank huge profits. Labour raised £5.2 billion from the measure. Sanger of EY, who worked on the tax for then-chancellor Gordon Brown, noted that the measure had been in Labour’s election manifesto, giving companies plenty of notice. “By including it in the manifesto, it was clear that there would be no other windfall tax,” he said.

Margaret Thatcher and her chancellor, Geoffrey Howe, imposed a windfall tax in 1981 — a 2.5 per cent levy on bank deposits

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In 2009, after the advent of the financial crisis, Labour levied a one-off 50 per cent tax on bankers’ bonuses, which brought in £2 billion — far more than the £550 million that had been expected. It differed from the previous windfall taxes in being prospective, rather than retrospective. It was supposed to discourage bank largesse, but instead, it encouraged companies to hand out even more to make up for the shortfall in take-home pay.

Banks continued to feel the pain under the subsequent coalition and Conservative governments, with the introduction of the banking levy and bank surcharge, the latter of which exists to this day — though neither was strictly a windfall tax in the sense they were not one-offs.

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Likewise, North Sea oil has been a regular target of tax hits. As early as 1980, Howe imposed an extra levy on the oil and gas industry, only to abolish it two years later. In 2002, Brown introduced a supplementary charge of 10 per cent on energy company profits, and doubled it in 2005 after the likes of BP and Shell reported bumper profits from higher prices. The déjà vu does not end there: Brown committed the funds raised towards the “Warm Front” scheme — to help poorer households with energy bills and home insulation. The industry warned that the measure would “severely undermine business confidence”, but this did not stop the coalition from raising the charge in 2011.

Deep freeze

Dire warnings that fresh taxes could send oil and gas investment into a deep freeze have returned to the fore. The industry argument goes that gas will be needed for decades to come as a “transition fuel” while countries target net-zero emissions by 2050. In particular, gas will have to plug a shortfall as coal-fired power stations close and ageing nuclear plants are retired. As recent price spikes have shown, demand for gas could remain higher than usual for years to come.

“If anything, the UK needs more gas, not less right now,” Looney said last week. “That’s going to require more investment … A windfall tax probably isn’t going to incentivise [that].”

BP and Shell have both been reducing operations in the North Sea to focus on easier, and more profitable, basins. In their place have come smaller operators, such as Serica Energy, which reckons it can still eke out profits from older wells.

Mitch Flegg, Serica’s chief executive, said UK gas had lower emissions than imports, such as the liquefied natural gas that comes from the likes of Qatar. But he warned: “A windfall tax may make it more difficult for companies such as ours to continue making the level of investment we’re planning in the next few years. That may lead to further shortages and price volatility.”

Looney argued that BP’s profits would be reinvested in green energy such as offshore wind and hydrogen — exactly the type of investment, and jobs, that the UK needs. Moreover, energy companies were racking up huge losses as recently as 2020, when oil prices briefly turned negative. BP and Shell recorded combined losses of $42 billion that year. As another industry executive put it: “You take the risk, but you do expect a reward. What you don’t expect, after years of hardly any money coming in, is to get that money taken off you.”

Harriet Harman, Alistair Darling and Gordon Brown at the Labour Party conference in 2009. That year the government levied a one-off 50 per cent tax on bankers’ bonuses

BEN GURR FOR THE TIMES

The economic theory holds that a windfall tax should not change the behaviour of the market because it is a unique event. Not everyone buys that. “Nobody would believe it was a one-off,” said one chief executive. “And the history of these things is that even when governments promise to remove it when prices go down, they are slow to take it away.”

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OGUK points to figures that show exploration for new fields cooled rapidly after the tax hike in 2011. But Professor Michael Jacobs, specialist in political economy at the University of Sheffield, said: “It cannot be the case that this is going to hit investments, because these companies have got much more money than they were expecting.” The former adviser to Brown, who described Labour’s proposed tax increase as “modest”, said: “You would expect them to invest more, not less.”

Labour’s proposed tax would only hit the profits made by oil companies in the North Sea, rather than their global earnings. Some have questioned how this would work in practice as some big firms do not break out UK profits. Moreover, not all energy companies make money at the market, or “spot” price, of gas; many sell forward their product at fixed prices. Those that have hedged sales in this way will not be banking as much profit. Nor would a windfall tax apply to Norweigian producers, who supply a large proportion of UK gas.

Dibb of the IPPR argued that the physical location of oil and gas resources lowered the likelihood of firms quitting the North Sea. “It’s not like a tech firm moving from New York to Dublin,” he said. “It’s highly unlikely they’ll go elsewhere.”

There is another argument that a windfall tax may simply miss the point. While it can act as a sticking plaster to help households facing the dire choice between heating and eating, it would do little long term to address energy supply, security and prices — let alone the transition to net zero. “With a windfall tax, you’re not discouraging people from consuming energy, which is what the UK should do if it wants to achieve climate neutrality,” said Alice Pirlot of the Centre for Business Taxation at Oxford University. Such a move would most probably require a “rethink of the entire UK tax system”, she said. Professor Jacobs suggested a more creative approach: “We need to insulate homes better so people don’t need to use as much energy. That’s the way to keep bills down.”

History of one-off hits

November 1980 Magaret Thatcher’s chancellor, Geoffrey Howe, raises tax on oil and gas producers

March 1981 Howe’s budget introduces a windfall 2.5 per cent tax on bank deposits

July 1997 New Labour implements a manifesto commitment to bring in a windfall tax on privatised companies such as BT, British Gas and the airports authority BAA

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April 2002 Gordon Brown introduces supplementary tax on oil and gas profits. It is raised again three years later

December 2009 Alistair Darling, the chancellor at the time, imposes one-off levy of 50 per cent on any banking bonus above £25,000

January 2011 Coalition government introduces banking levy; the rate is adjusted over time. The same year, George Osborne raises the surcharge on the North Sea to 32 per cent, before reducing it again.

July 2015 Conservative government announces the bank surcharge – an extra 8 per cent on profits in addition to corporation tax, while reducing the bank levy

December 2019 Labour proposes windfall levy on oil and gas companies in election manifesto

March 2021 Rishi Sunak raises corporation tax from 2023 but reduces the bank surcharge; overall tax for banks will go up slightly to 28 per cent

January 2022 Labour and the Liberal Democrats call for windfall tax on oil and gas producers

A quick look at robots and jobs

 

The robots are gathering to help beat Britain’s supply-chain shortages

Building automated warehouses

Some 3,000 boxy robots, each the size of a small refrigerator, are scurrying around a metallic chequerboard about seven times the size of a football pitch. Every second or so one halts as a crate of groceries rises up and is deposited inside it. The bot then conveys the crate to a picking station, where a human puts orders into bags. This is the “Hive” (pictured), a giant fulfilment centre in Erith, south-east London, operated by Ocado, an online grocer. An ai-driven computer system choreographs the bots’ movements. Each travels some 60km a day, helping to bag around 1m items.

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Brexit and a shortage of lorry drivers mean items are missing from supermarket shelves. But further up supply chains, the picture is cheerier, for a nation of shopkeepers has built some of the world’s most advanced retail logistics. With around £350,000 ($450,000) spent on automation per warehouse in 2020, Britain’s distribution and fulfilment centres are the world’s most robotised, according to Interact Analysis, a research group. In America, for comparison, the figure is $375,750.

Automation was first motivated by high wage costs, says Ash Sharma, Interact’s managing director. Britain spends $18 per square foot on warehouse labour, compared with $16 in America and $4 in China. But now the issue is labour shortages: “Firms just can’t find workers.”

Britain was also an early mover in e-commerce. Amazon set up its virtual British store in 1998, three years after the American original. Its British fulfilment centres use small, squat robots to slide under shelves and shuttle them to people who pick and pack the right goods

Online shopping has been the main source of demand. From barely 3% in 2006, the share of retail sales in Britain made online has risen to 26%. When Ocado began delivering groceries ordered online in 2002, there was little technology for automating the handling of goods that must be kept chilled or frozen. So it developed its own. Nowadays, Ocado Group provides robotics to other retailers. It is building 50 more Hive-like systems around the world.

On the shopping list

To keep up, firms need supply chains to become more efficient, not just for e-commerce but also for bricks-and-mortar stores, as the two have become entwined. Nowhere is this more apparent than in a giant warehouse beside the m1 motorway at Northampton. Cygnia, the logistics firm that owns it, handles warehousing and order fulfilment for some 30 retailers, selling goods ranging from beer to beauty products. Its employees pick and pack from tens of thousands of items, not just for online customers, but also for shops, beauty salons and other businesses.

Things get hectic at this time of year. A recent Black Friday offer by one client resulted in two days’ worth of off-peak order volume in an hour, says Scott Merrick, Cygnia’s chief information officer. The firm also has to cope with constant change, in the form of new products and customised packaging such as Christmas gift boxes. All this is a problem for robots, which, unlike humans, struggle with variety.

Nevertheless, they are coming. Cygnia was bought in September by Wincanton, a giant logistics firm that got its start almost a century ago delivering milk in the West Country. It will introduce robots similar to some it uses elsewhere that work like automated trolleys, fetching items to spare workers from pushing things around. Mr Merrick expects a 200% increase in productivity with two-thirds less labour.

Cygnia says workers displaced by robots will be redeployed, as the firm is expected to grow. Indeed, automation can create jobs, not just for technicians and programmers, but also because improved efficiency tends to generate additional business, says Rueben Scriven, a senior analyst with Interact. He already sees signs of a net increase in warehouse employment.

How long that continues will depend on how well engineers succeed in automating jobs that robots find tricky. It takes dexterity and knowledge not to drop a bag of potatoes on a box of eggs. With the help of sensors and ai, one-armed robots at Ocado’s warehouse in Erith are learning the ropes. They can already pick and pack about 10% of the 50,000 product lines stored in the Hive, says James Gralton, chief engineering officer for Ocado’s technology division. He thinks that could rise to 60-80% over time.

Vehicles such as forklift trucks and goods transporters will also start to be automated, says Ian Hunt, automation and engineering director for Wincanton. And companies are keen to automate the “last mile”—the bit of the supply chain that ends with the customer. Starship Technologies, an Estonian firm, already offers robotic delivery in Northampton and Milton Keynes. Its six-wheeled pods trundle along footpaths and cycleways to deliver groceries from Co-op stores, using sensors to avoid people and other vehicles. Operators monitor the pods’ progress through their cameras and can take control if necessary. When the pods arrive, they are unlocked by shoppers using a mobile app.

As technologies improve and regulators allow, bigger autonomous delivery vans using roads will arrive. Wayve, a London-based startup, is running trials, including some with Asda, a supermarket chain, and Ocado. For now vehicles have “safety drivers” on board as backup. Lorries will also gain automated-driving aids to help with lane-keeping and avoiding other vehicles. But the complexity of their operations—try reversing a big lorry through a busy, narrow high street to drop goods off at a convenience store—means hgv drivers will be in demand for years to come.

The John Mauldin Thoughts From The Frontline letter on central banks

 Absolutely vital reading:

Time to Rethink the Fed By John Mauldin | Feb 5, 2022    Who Needs Central Banks? A Benchmark for Everything This Can’t Continue How Then Should We Change the Fed? Planning to Travel, Not Sure When “In many important ways, the financial crash of 2008 had never ended. It was a long crash that crippled the economy for years. The problems that caused it went almost entirely unsolved. And this financial crash was compounded by a long crash in the strength of America’s democratic institutions. When America relied on the Federal Reserve to address its economic problems, it relied on a deeply flawed tool. All the Fed’s money only widened the distance between America’s winners and losers and laid the foundation for more instability. This fragile financial system was wrecked by the pandemic and in response the Fed created yet more new money, amplifying the earlier distortions.” —Christopher Leonard, The Lords of Easy Money (2022) (h/t Michael Lewitt) One of the hardest leadership challenges is knowing when to change plans. Is what you could do better than what you are doing? Certainty is impossible. At some point, though, good leaders recognize their plans aren’t going well and start looking for better ones. I believe the Federal Reserve is there. I don’t mean the Fed’s current policy dilemma. I mean the Fed itself; its very existence, structure, and goals. They need a complete restructuring, because the Fed isn’t accomplishing what we all need it to. Worse, it is causing problems we could do without. I believe Fed officials are largely responsible for the cycles of bubbles, booms, and busts over the last 30 years. Further, they share some of the blame (clearly not all) for the growing divisions and tribalism in our society. Much of it springs from the wealth disparity they aided and abetted. I’ve talked before about how the Fed has painted itself into a corner. All the options are bad and getting worse. The reasons it is in this position are no mystery. Indeed, this is all inherent in the Federal Reserve system’s design. It is trying to do things it shouldn’t be attempting. The only real solution is a wholesale redesign and reconstruction. What we have today isn’t working and the time has come to amend the Federal Reserve Act and change its purposes and authorities. I realize these are bold words. I fully acknowledge the gravity of what I’m proposing here. And I am totally open to ideas of what a new and better Fed would look like. I know any transition from here to there will be tricky, too. It also will take time. I do not expect anything to happen of any substance until we get to The Great Reset, where we will be forced to think and do many things now unthinkable in the current environment. In the meantime, I fully expect the current Federal Reserve will increasingly inject itself into the economy and make things worse. Its leaders will do so with the best of intentions, because they believe their own dogma. In their view, this is just what they do. We need to have this conversation and it has to start somewhere. So today I’ll start it. Who Needs Central Banks? We should first ask why the Federal Reserve (or any other central bank) is even necessary. Answering that leads quickly to much deeper questions, like what is “money” and who should create/control its value. Many libertarians and Austrian-school economists argue governments should have no role at all. I probably would’ve been sympathetic to that in the late 19th century and early 20th century. I will now no longer argue for the Fed’s full dissolution. We need central banks with limited capabilities, just like young children need training wheels. My goal is to improve the present system and reduce its harmful side effects. Modern central banking is fairly new. Until the 19th century private banks commonly issued their own currency notes, sometimes linked to gold but not always. Wars and political machinations created instability, with periodic panics and bank runs. Banking was not a “system” as we know it today. Banks did their own thing, and if yours had trouble it was your problem, too. Let’s stop here and make an important distinction. Today we associate central banks with “fiat money” without independent backing like gold. That’s not always the case. You can have both a gold standard and a central bank at the same time. A central bank standing behind individual banks helps maintain stability, thereby promoting the confidence that attracts deposits. This would be important even in a 100% reserve system. In the 1870s the Bank of England pioneered the “lender of last resort” concept. British writer Walter Bagehot (a co-founder of The Economist magazine) famously summarized the central banks’ job as averting panic by “lending freely, to solvent firms, against good collateral, and at high rates.” That isn’t what today’s Federal Reserve does. In particular, it doesn’t follow the “high rates” part of Bagehot’s advice. This, I think, is key to many of our problems. A Benchmark for Everything As lender of last resort, a central bank stands ready to always loan a commercial bank enough cash to repay depositors. This doesn’t always mean the bank is in trouble. Money flows in and out every day and sometimes gets unbalanced. In the US, “federal funds” are available overnight to fill these gaps, for which banks pay interest at the federal funds rate, the amount of which is set by the Federal Open Market Committee (FOMC). This rate has grown far beyond the limited purpose of simply enhancing bank liquidity. It has become the benchmark for everything. The entire global economy now hinges on a price subjectively determined by a committee of a) politically appointed Governors and b) regional Fed presidents selected by boards who represent their region’s commercial banks. Unlike other prices, it isn’t a function of supply and demand. The rate can be as high or as low as the committee wants. The FOMC members set the rate at whatever they think will achieve what they believe are good economic goals. But that has economic consequences. It all seems so logical when they explain it. But the reality is that we have been through multiple bubbles brought about by ever-lower interest rates in an effort to avoid recessions and improve employment (laudable goals to be sure) and in recent years a new tool: quantitative easing (QE). The Federal Reserve Act gives the Fed a “dual mandate.” It is required to promote both full employment and price stability. Unfortunately, its monetary policy tools have at best a distant influence on employment. Creating the conditions that let businesses create jobs is really a fiscal and regulatory function. Congress and the president should be doing that part. The Fed should focus on price stability. Fed proponents point to a correlation between Federal Reserve efforts and unemployment. I would argue that this is correlation without causation. Jobs are created when entrepreneurs recognize business opportunities and need workers to achieve them. As for price stability, the Fed defines “stability” as inflation averaging 2% yearly. That’s not stability. A 2% inflation rate will, over a typical worker’s lifetime, consume a large part of the buying power of their savings and leave them anything but “stable.” Moreover, the Fed hasn’t produced consistent price stability despite its many tools. Inflation was well below target for most of the last decade (based on the Fed’s own benchmarks, though consumers certainly saw higher inflation in their living costs). Now inflation is far above their target. The Fed’s choice to keep rates low and continue massive QE is having serious side effects. This Can’t Continue As you know, there are interest rates and “real” interest rates (nominal interest rates minus the inflation rate), which account for the fact the currency with which a borrower repays may have changed value before repayment was due. The Fed is now taking this to extremes, as former Morgan Stanley Asia chair Stephen Roach explained in a recent Project Syndicate piece. Quoting (emphasis mine): “Consider the math: The inflation rate as measured by the Consumer Price Index reached 7% in December 2021. With the nominal federal funds rate effectively at zero, that translates into a real funds rate (the preferred metric for assessing the efficacy of monetary policy) of -7%. “That is a record low. “Only twice before in modern history, in early 1975 and again in mid-1980, did the Fed allow the real funds rate to plunge to -5%. Those two instances bookended the Great Inflation, when, over a five-year-plus period, the CPI rose at an 8.6% average annual rate. “Of course, no one thinks we are facing a sequel. I have been worried about inflation for longer than most, but even I don’t entertain that possibility. Most forecasters expect inflation to moderate over the course of this year. As supply-chain bottlenecks ease and markets become more balanced, that is a reasonable presumption. “But only to a point. The forward-looking Fed still faces a critical tactical question: What federal funds rate should it target to address the most likely inflation rate 12–18 months from now? “No one has a clue, including the Fed and the financial markets.” A -7% real interest rate is simply bizarre. It means anyone who can borrow at the fed funds rate, or close to it, is effectively being paid to take on more debt. And not just paid but paid well, plus whatever return they can generate with the borrowed money. This is partly why so many asset prices are so bubble-like today. Now, real rates may moderate somewhat in 2022 as inflation eases and/or the Fed raises rates. But even the most hawkish scenarios would only bring it back to the 0% range, which is still not normal. Negative rates were increasingly normal even before the current inflation. I wrote a long letter about it back in August 2016: Six Ways NIRP Is Economically Negative. I showed how the Fed and other central banks were ignoring even their demigod, Lord John Maynard Keynes. Following a long Keynes quote I said this: To paraphrase, Keynes is saying here that a lower interest rate won’t help employment (i.e., stimulate demand for labor) if the interest rate is set too low. Interest rates must account for the various costs he outlines. The lender must make enough to offset taxes and “cover his risk and uncertainty.” Zero won’t do it, and negative certainly won’t. The footnote in the second paragraph is important, too. Keynes refers to “the nineteenth-century saying, quoted by Bagehot, that ‘John Bull can stand many things, but he cannot stand 2 per cent.’” Is Keynes saying 2% is some kind of interest rate floor? Not necessarily, but he says there is a floor, and it’s obviously somewhere above zero. Cutting rates gets less effective as you get closer to zero. At some point it becomes counterproductive. The Bagehot that Keynes mentions is Walter Bagehot, 19th-century British economist and journalist. His father-in-law, James Wilson, founded The Economist magazine that still exists today. Bagehot was its editor from 1860–1877. (Incidentally, if you want to sound very British and sophisticated, mention Bagehot and pronounce it as they do, “badge-it.” I don’t know where they get that from the spelling of his name. That’s an even more unlikely pronunciation than the one they apply to Worcestershire.) Bagehot wrote an influential 1873 book called Lombard Street: A Description of the Money Market. In it he describes the “lender of last resort” function the Bank of England provided, a model embraced by the Fed and other central banks. He said that when necessary, the BoE should lend freely, at a high rate of interest, with good collateral. Sound familiar? It was to Keynes, clearly, since he cited it in the General Theory. Yet today’s central bankers follow only the “lend freely” part of this advice. Bagehot said last-resort loans should impose a “heavy fine on unreasonable timidity” and deter borrowing by institutions that did not really need to borrow. Propping up the shareholders of banks by lending low-interest money essentially paid for by the public when management has made bad decisions is not what Bagehot meant when he said that the Bank of England should lend freely. How did the Fed act in 2008? In exact opposition to Bagehot’s rule. They sprayed money in all directions, charged practically nothing for it, and accepted almost anything as collateral. Not surprisingly, the banks took to this largesse like bees to honey. Taking it away from them has proved very difficult. We now find ourselves in an era of speculation about what will happen when interest rates are raised. A few months after that letter, the Fed embarked on a two-year tightening phase that took rates about two percentage points higher. Even that small, slow change was more than markets could handle. The Fed gave up and resumed cutting in mid-2019. Then COVID hit and here we are, in a mess with no good way out. This can’t continue. The Federal Reserve and its peers need to get back to boring, Bagehot-style central banking and stop trying to micromanage the entire economy. The mere attempt generates yet more problems. The free (or better than free) money environment they’ve created makes every other challenge worse. How Then Should We Change the Fed? So what can we do? I think we abolish the dual mandate and have the Fed focus squarely on inflation. That will be easier if full employment isn’t on their plate, too. As noted above, the link between low interest rates and employment is tenuous, if it exists at all. Further, 2% inflation should be seen as high. The Fed should be leaning into inflation (tightening monetary policy) at 2% inflation and ease policy when inflation is at 1% or lower. Period. It goes without saying that we need better inflation tracking tools, too. The Federal Reserve should not be this all-powerful “manager” of the economy. The Fed has taken on a third unwritten mandate, that of “financial stability,” which really means stock market stability. The low rates that keep the stock market happy also financialized the entire economy. It is now cheaper to buy your competition than to actually compete. Private equity has evolved the way it has because low rates make it possible to buy good businesses, add cheap leverage, and over time generally produce well-above-market returns. None of it is available to the bottom 80% of the population, meaning the rich get richer. The financialization of the economy has been one of the greatest ills brought about by a loose monetary policy. Jeremy Grantham said in his recent piece: “Perhaps the most important longer-term negative of these three bubbles, compressed into 25 years, has been a sustained pressure increasing inequality: to participate in the upside of an asset bubble you need to own some assets and the poorer quarter of the public owns almost nothing. The top 1%, in contrast, own more than one-third of all assets. And we can measure the rapid increase in inequality since 1997, which has left the U.S. as the least equal of all rich countries and, even more shockingly, with the lowest level of economic mobility, even worse than that of the U.K., at whom we used to laugh a few decades back for its social and economic rigidity. “This increase in inequality directly subtracts from broad-based consumption because, on the margin, rich people getting richer will spend little to nothing of the increment where the poorest quartile would spend almost all of it. So, here we are again. This time with world-record stimulus from the housing bust days, followed up by ineffably massive stimulus for COVID. (Some of it of course necessary—just how much to be revealed at a later date.) But everything has consequences and the consequences this time may or may not include some intractable inflation.” The economy can manage itself (with a few rules, of course). We just need stable money, a stable economic environment, and an honest, reliable banking system. A great deal of the Fed’s activity has nothing to do with what should be its core mission. As bureaucracies do, it has grown too powerful and invented new reasons to justify its existence. That’s not any one person’s fault, nor is it a partisan political thing. Getting us into this mess was a long-term bipartisan comedy of well-intentioned errors. Finding a solution is more important than pinning blame. We have to start somewhere and now is the time. A few final thoughts: As I keep saying, we will eventually come to a financial reckoning I call The Great Reset. It will require us to rationalize debt, reduce government spending, and increase taxes. Otherwise we will fall into very difficult economic times. Not the end of the world, but still difficult. The Fed will continue doing what it does, up to the moment of actual crisis, helping bring it about, and then offer to put out the fire it helped create. Failure to reform the Fed will let it continue to create bubbles and distort the economy. Starting this conversation now will help us have proposals ready when the time is right. There are others far more knowledgeable than I am who can provide better ideas and insight. I am simply observing a pattern that has developed over 25 years of loose monetary policy beginning with the Greenspan Fed, which is responsible for many ills. This is a serendipitous time to begin this discussion, with pushback against authorities across the spectrum “speaking down” to the hoi polloi. We live in a time of dueling experts, with one group of experts wanting to censor others or drown out alternative, competing ideas. The Fed is part of that system, led by a group of people who believe they know better how to manage a $20 trillion economy than businesses and consumers themselves. They have created all sorts of unintended consequences, none of which they assume responsibility for, because their theories tell them that what they are doing is correct and those consequences are caused by something else. They are like Plato’s philosopher kings. “Trust us, we know how to run your lives.” The Federal Reserve is just one of many institutions that need rethinking. But while we do it, let’s make sure we take care of the Fed. We need a properly managed Fed for crises like we saw in early 2020, but it must have limits