Macro on Philipp D. Dubach | Quantitative Finance & AI Strategy

People Live in Levels, Not Rates

me@philippdubach.com (Philipp D. Dubach) — Sat, 28 Feb 2026 00:00:00 +0000

Economics doesn’t take into account what’s best for society. The goal of economics in a capitalist system is to make the most amount of money for your shareholders.

That’s Jon Stewart, telling a Nobel laureate what his own field is about. On February 4, Stewart hosted Richard Thaler on “The Weekly Show” to discuss behavioral economics. Thaler, the Chicago Booth professor who won the 2017 Nobel for his work on how real humans deviate from rational-agent models, spent 92 minutes patiently explaining things Stewart had already decided weren’t true. Jason Furman, Harvard professor and former Obama CEA chair, called it “the single worst interview I’ve ever done” (referencing his own 2024 Stewart appearance). That tweet hit 754,000 views. Jerusalem Demsas wrote the sharpest rebuttal, arguing Stewart “has no idea what economics actually is.”

The pile-on was deserved in its specifics and wrong in its framing. Stewart got basic things wrong. He also pointed at something real that the profession keeps failing to address.

The carbon tax moment

The episode’s most telling exchange involved climate policy. Thaler offered the textbook answer: a carbon tax. Every economist agrees on this, Thaler said, and he’s roughly right. Stewart rejected it on political grounds: the moment energy prices rise, voters punish the party in power. Fair enough. But then Stewart proposed his own solution: “create a model that creates robust markets in damage mitigation and carbon mitigation.” Thaler paused. That is a carbon tax. Stewart had arrived at the standard economic answer while believing he was overturning it.

This moment captures the entire problem. Stewart’s instinct, that political feasibility should constrain policy design, is not a “bizarre non sequitur” as some economists claimed. It’s the reason we don’t have a carbon tax. But his conviction that economics as a discipline has nothing to say about society’s wellbeing is wrong in a way that matters. Thaler’s own career is a direct counterexample: behavioral nudges have enrolled 10 million UK workers into pension savings, and Thaler told Stewart that renaming an ACA plan tier from “catastrophic” to “economy” cut the uninsured rate by 10%. But I think the economists who piled on Stewart missed the more interesting question he was circling: if the economy is working well by standard measures, why does it feel broken to so many people? The answer is what I’d call the levels-vs-rates problem, and it explains both the vibecession and the trust gap between economists and the public they claim to serve.

Levels-vs-rates disconnect

The headline data is strong. GDP grew 4.4% annualized in Q3 2025. Unemployment sits at 4.3%. Inflation has fallen to 2.4%, with core CPI at 2.5%, its lowest since April 2021. Real wages have outpaced inflation every month since June 2023. The S&P 500 posted three consecutive years of double-digit gains, returning 86% cumulative. An economist looking at these numbers would say the economy is performing well. Thaler more or less said exactly that.

But rates and levels are different things, and people live in levels. The cumulative CPI increase since early 2020 is roughly 25%. Food-at-home prices are up 29.4% since March 2020. The $150 grocery bill became $186 and will never go back to $150. Housing affordability is at its lowest point since the 1980s, with home prices up 30-45% from pre-pandemic levels and mortgage rates near 6%, more than double the 2.65% pandemic low. ACA marketplace premiums rose 21.7-26% for 2026, the largest increase in nearly a decade. The rate of change has normalized. The level shift is permanent.

This is what Stewart was gesturing at. He expressed it as “economics doesn’t care about people,” which is wrong. What he actually meant: the metrics economists use to declare success (rates of change, aggregate growth, unemployment) don’t capture what households experience at the grocery store, the mortgage broker, or the insurance renewal. The economic perception gap isn’t irrational. It’s a measurement problem.

K-shaped wages: the recovery that reversed

The distributional story makes both sides’ aggregate claims misleading. The Economic Policy Institute reported in February 2026 that low-wage workers’ real wages declined in 2025, ending five years of historically fast gains. High earners held steady at 4.5% wage growth. The lowest-income quartile fell from 7.5% to roughly 3.5%. The pandemic-era wage compression that closed up to one-third of the post-1979 wage gap, documented by Autor, Dube, and McGrew in their 2023 paper, has reversed. CNBC reported that the top 1% now hold roughly 32% of US net worth (about $52 trillion), while the bottom 50% hold 2.5%. Eight percent of American households have zero or negative net worth.

The University of Michigan consumer sentiment index sits at 57.3: the 3rd percentile of its entire historical range. The Conference Board’s Consumer Confidence Index hit 84.5 in January, a 12-year low. Charles Schwab’s Kevin Gordon coined the term “vibepression” in December 2025 as sentiment hit new lows. Kyla Scanlon’s original “vibecession” concept from 2022 never actually resolved; it just got a bleaker name.

I’m not sure consumer sentiment surveys mean much anymore. A 50-point partisan gap between Republicans and Democrats renders the aggregate figure almost meaningless as an economic indicator. It tells you about political identity, not lived experience. But the affordability data underneath the sentiment numbers is not a polling artifact. Mike Konczal’s February 2026 analysis showed that budget shares devoted to essentials, food, shelter, transportation, and healthcare, have increased even as aggregate real incomes recovered. He called this the “essentials squeeze,” and dismissed the standard economist response (“it’s just money illusion”) as inadequate. I think he’s right.

Economists’ communication problem

The Nominal News author, a PhD economist, made the argument I find most persuasive: Stewart’s view of economics is wrong, but the reason he holds it is because the profession has failed to distinguish between what it actually does and the policy opinions individual economists express in op-eds and cable news appearances. When a prominent economist dismisses wealth taxes by citing implementation costs as if costs alone settle the question, they’re blending analysis with preference. Do that enough times, and people like Stewart conclude that the entire field is an exercise in defending the status quo.

Demsas catalogued economics’ accomplishments: Alvin Roth’s kidney exchange, RCTs delivering tutoring to 5 million Indian children, longer intervals between recessions. These are real. But the profession’s most visible public-facing moments, failing to predict 2008, designing a response perceived as rescuing banks over households, insisting the economy is strong while consumer sentiment sits near all-time lows, have eroded trust in ways that one good Substack post can’t repair.

Stewart then brought on Oren Cass to discuss financialization, which prompted Demsas to write: “Damn, I felt bad for a second but Stewart may be beyond help.” The irony is thick. The populist left (Stewart) and the populist right (Cass) are making the same structural complaint about economics from opposite directions. Stewart says economics serves capital. Cass says economics serves free trade orthodoxy. Both are wrong about the discipline and right that its public-facing representatives have blurred the line between analysis and advocacy for decades.

Here’s where I land. Nudge theory works in specific, bounded domains: default enrollment, plan labeling, organ donation opt-outs. A meta-analysis by Maier et al. found that real-world nudges increase desired behavior by an average of 1.4 percentage points after correcting for publication bias, versus 8.7 in lab settings. Useful but limited. Stewart’s “nudge vs. shove” framing is crude. Thaler’s point that mandates become dangerous when political control shifts (“Sometimes Trump is President”) is underrated. But neither addressed the actual hard question: what do you do about a permanent 25% price level shift in essentials that no nudge can reverse and no rate-of-change metric captures?

I don’t think anyone has a good answer to that. The economists who piled on Stewart for not understanding Pigouvian taxation weren’t wrong. They just weren’t answering the question their audience was asking.

Europe's $24 Trillion Payment Breakup Is Really a Bet on Infrastructure Arbitrage

me@philippdubach.com (Philipp D. Dubach) — Mon, 16 Feb 2026 00:00:00 +0000

On February 2, 2026, the European Payments Initiative signed a Memorandum of Understanding with the Alliance EuroPA, a consortium linking Spain’s Bizum, Italy’s Bancomat, Portugal’s SIBS, and the Nordic Vipps MobilePay system. The deal connects 130 million users across 13 countries into a single interoperable payment network. Headlines framed it as Europe breaking up with Visa and Mastercard. The actual story is more interesting: Europe is attempting an infrastructure arbitrage that, if it works, could reprice how money moves across the continent.

This is not primarily a sovereignty play, though that is how politicians sell it. It is an attempt to exploit a structural pricing inefficiency in European payments that Visa and Mastercard have maintained for decades and that the EU’s own regulation accidentally made harder to dislodge.

I. The hidden fee structure

The EU’s 2015 Interchange Fee Regulation capped consumer debit interchange at 0.2% and credit at 0.3%. This was celebrated as a win for merchants. What happened next was predictable to anyone who has watched regulated industries: Visa and Mastercard shifted revenue to unregulated “scheme fees” for authorization, clearing, and settlement. According to EuroCommerce, scheme fees rose by a cumulative 33.9% between 2018 and 2022, averaging 7.6% annually. The European Commission’s own data shows scheme fees increased by €1.46 billion between 2016 and 2021. Ecommerce Europe found that the average net merchant service charge nearly doubled from 0.27% to 0.44% between 2018 and 2022, effectively neutralizing the entire regulatory benefit.

A card transaction through Visa or Mastercard can cost a European merchant up to 2% when all components are included. A SEPA Instant Credit Transfer, the rails that EPI’s Wero system uses, processes payments for a fraction of that with near-zero interchange and only processing fees. In Germany, S-Payment has proposed Wero merchant pricing at 0.77% plus gateway charges. That spread, roughly 100 to 120 basis points on every transaction, is the arbitrage opportunity. Applied to the $4.7 trillion in combined Visa and Mastercard European volume, we are talking about tens of billions of euros annually in fees that could theoretically be disintermediated.

Most analysis I read over the past days focuses on whether Wero can beat Visa and Mastercard on user experience or brand recognition. But Wero does not need to win on UX. It needs to win on cost, and the cost advantage is structural because account-to-account payments simply skip an entire layer of intermediation. The question is whether that cost advantage is large enough to overcome the switching costs, and whether the political will exists to force adoption where market forces alone might not.

II. What Wero actually is and why the impact of the EuroPA deal

Wero is a digital wallet built on top of SEPA Instant Credit Transfer infrastructure. Users access it through their existing banking app. Payments move directly between bank accounts in under 10 seconds using a phone number, email, or QR code. No card, no card network, no intermediary skimming basis points off each transaction.

EPI launched Wero for peer-to-peer transfers in Germany on July 2, 2024, followed by France in September and Belgium in November of that year. E-commerce payments went live in Germany in November 2025, with merchants including Lidl, Decathlon, and Rossmann accepting it. Point-of-sale NFC tap payments are planned for 2026 to 2027.

The 16 founding bank shareholders include BNP Paribas, Crédit Agricole, Société Générale, Deutsche Bank, the Sparkassen-Finanzgruppe (which alone committed €150 million), ABN AMRO, ING, Rabobank, and pan-European acquirers Nexi and Worldline. Total committed capital sits at roughly €500 million. Membership has expanded to over 1,100 institutions, and both Revolut and N26 joined in 2025.

Before the EuroPA deal, Wero was a Franco-German-Benelux payments app with roughly 47 million users and a geographic footprint that excluded most of southern and northern Europe. That is not a challenger to Visa and Mastercard. The EuroPA deal changes the math because it connects Wero with Bizum’s 30.6 million users in Spain, Bancomat’s dominant network in Italy, SIBS in Portugal, and Vipps MobilePay’s 12.5 million users across the Nordics. Crucially, it does this through a hub model rather than requiring each country to join EPI as a shareholder. This is a key architectural choice because the shareholder approach already failed once: in 2021 and 2022, roughly 20 banks withdrew from EPI, including all Spanish institutions, over disagreements about governance and cost sharing.

The hub model lets national systems keep their local brands and governance while gaining cross-border interoperability. A Bizum user in Madrid will be able to pay a German merchant. An Italian Bancomat customer can transfer money to someone in France. 130 million users is not just a bigger number than 47 million, it is the difference between a niche product and something that forces merchant adoption.

EPI also acquired two established national payment systems outright. iDEAL in the Netherlands processes 1.5 billion transactions annually and handles 72% of Dutch e-commerce. Payconiq/Bancontact dominates in Belgium and Luxembourg. Both acquisitions completed in October 2023. iDEAL will transition to Wero branding by end of 2027. In France, the pre-existing Paylib service with 35 million users was directly replaced by Wero at launch. These are not greenfield user acquisition plays. They are migrating existing transaction volumes onto a unified pan-European rail.

III. The geopolitical accelerant

The economics alone might not have been enough to generate the political will for this kind of project. What changed was Russia. When Visa and Mastercard suspended operations in Russia in March 2022 following the invasion of Ukraine, they severed a market where they controlled approximately 72% of card payments. The intended target was Moscow. The unintended lesson was Brussels: payment networks controlled by American corporations can be weaponized, and what gets deployed against Russia could theoretically be turned against Europe (see my earlier post on Bretton Woods III).

ECB President Christine Lagarde has become the initiative’s most vocal political champion. In early February 2026 she told Irish radio that whether Europeans use a card or a phone, the transaction typically flows through Visa, Mastercard, PayPal, or Alipay, all of which originate from either the US or China. ECB Executive Board member Piero Cipollone has been more direct, arguing that Europe’s dependence on non-European payment solutions puts it at the mercy of decisions made elsewhere. In March 2025, ECB Chief Economist Philip Lane warned that this dependence leaves Europe “open to coercion.”

Trump’s second term has sharpened these concerns considerably. EPI CEO Martina Weimert told the Financial Times that the problem with the digital euro is that it will arrive in a few years, perhaps after Trump’s term ends, so she thinks Europe is somewhat short on time. Tariff threats, territorial claims over Greenland, and a pro-crypto, anti-CBDC US policy agenda have turned European payment sovereignty from a technocratic aspiration into something closer to a defense priority. And European defense spending is the one area where political consensus currently exists across virtually all member states.

This matters for understanding why Wero might succeed where its predecessors failed. The Monnet Project collapsed in 2012 when the European Commission refused to support multilateral interchange fees. The original EPI card-scheme vision was abandoned after the bank withdrawals. The Nordic P27 initiative collapsed in 2023. Each failure happened in a geopolitical context where the urgency was abstract. The urgency is no longer abstract. When 70 economists including Thomas Piketty published an open letter in January 2026 calling the digital euro “the only defence” against dependence on US payment systems, that represents a shift in the Overton window that did not exist even two years ago.

IV. Profitability

The EU’s own interchange fee regulation, the one designed to protect merchants from Visa and Mastercard, has inadvertently created what I think is one of the largest barriers to entry for any new European payment network.

When interchange is capped at 0.2% for debit, the revenue pool available to fund a new network is tiny. Visa and Mastercard can sustain their European operations because they amortize costs across a $24 trillion global transaction base. A new European entrant has to build comparable infrastructure, convince hundreds of thousands of merchants to integrate, and acquire tens of millions of users, all while operating in a margin environment that was deliberately compressed by regulation. Weimert herself has estimated that building a viable full-scale alternative requires “several billion euros,” with private estimates cited by Fortune ranging as high as €6 billion.

This is what often happen with bad regulation. The regulation that was supposed to weaken the duopoly has actually strengthened its competitive moat by making the economics of entry worse. Visa and Mastercard responded to interchange caps by raising unregulated fees, so their total revenue per transaction barely changed. But a new entrant cannot charge those same scheme fees without undermining its cost advantage proposition. The revenue has to come from somewhere else.

EPI’s answer is value-added services: buy-now-pay-later, digital identity, subscription management, loyalty programs. None of these exist yet. They are on the roadmap for 2027 and beyond. In the meantime, Wero operates as a cost center subsidized by its bank shareholders. The Sparkassen’s €150 million commitment is patient capital from a cooperative banking group with a 200-year time horizon. BNP Paribas and Crédit Agricole can absorb the costs as a strategic investment. But the question of when, or whether, Wero becomes self-sustaining is genuinely open.

V. India and Brazil comparisons are both more and less instructive than they appear

Every article about Wero mentions India’s UPI and Brazil’s Pix as proof of concept. The numbers are undeniably impressive. UPI processed 228.3 billion transactions worth approximately $3.6 trillion in 2025, up 29% year-over-year. The IMF recognized it in June 2025 as the world’s largest retail fast-payment system. Brazil’s Pix reached 175 million users and processed 63.4 billion transactions worth $4.6 trillion in 2024, growing 53% year-over-year. Both systems achieved in a few years what Visa and Mastercard built over decades.

But the structural conditions that enabled UPI and Pix do not map cleanly onto Europe. India had a large unbanked population and low existing card penetration. UPI did not have to displace an entrenched incumbent so much as fill a vacuum. Pix launched via central bank mandate requiring every financial institution to participate, with zero-cost transfers for individuals. Both countries also had single regulatory jurisdictions and populations accustomed to mobile-first payments.

Europe has none of these conditions. Card penetration is high. Consumer habits are entrenched. The regulatory patchwork spans 27 member states plus associated countries, each with their own banking traditions and payment preferences. There is no single authority that can mandate participation the way Brazil’s central bank did.

What Europe does have, and this is the part most analysts underweight, is a functioning SEPA infrastructure that already connects every bank account in the eurozone. Wero does not need to build new rails. It needs to build a user interface and merchant acceptance layer on top of rails that already exist and that already process trillions of euros annually. The SEPA Instant Credit Transfer regulation that became mandatory in 2025 means every eurozone bank must support real-time payments. Europe’s governments have already paid for the highway. Wero is building the on-ramps.

The other underappreciated advantage is regulatory asymmetry. The EU’s July 2024 ruling forcing Apple to open iPhone NFC access to third-party wallets means Wero can offer tap-to-pay on iPhones without going through Apple Pay. PSD3, expected in 2026, will likely further strengthen open banking requirements. The European Commission has active investigations into Visa and Mastercard’s fee structures. In the UK, the Competition Appeal Tribunal ruled unanimously in June 2025 that the networks’ interchange fee structures breach competition law. Europe is building an alternative while simultaneously making the incumbent’s business model harder to sustain.

VI. Visa and Mastercard

Neither company has made extensive public statements about Wero, which is itself a strategy: do not elevate the challenger’s profile. When pressed, they emphasize the value they provide. Mastercard CEO Michael Miebach argued on an October 2025 earnings call that wherever cards are available in a competitive, level playing field, businesses and consumers opt for cards because of the protections they offer.

But both companies are executing a quiet multi-rail pivot. Visa acquired European open banking leader Tink for approximately $2.2 billion in 2022, gaining the capability to offer the same account-to-account payment rails that Wero uses. Mastercard acquired cybersecurity firm Recorded Future for $2.65 billion in September 2024, expanding into value-added services. Both are positioning themselves as payment technology platforms rather than pure card networks.

This is rational. If account-to-account payments do take share from card networks in Europe, Visa and Mastercard want to be the infrastructure layer that processes those payments too. They have the merchant relationships, the fraud detection capabilities, and the global acceptance network. The risk for Wero is that even if it succeeds in shifting transactions off card rails, the toll collectors simply move to the new road.

The digital euro

Running in parallel is the ECB’s digital euro project, a central bank digital currency that would serve as legal tender across the eurozone. The EU Council agreed its negotiating position in December 2025. A European Parliament vote is expected in the first half of 2026, with potential first issuance around 2029. In October 2025, the ECB completed its preparation phase and declared the digital euro technically ready.

EPI positions Wero as complementary, handling private money while the digital euro handles public money. But the overlap in ambition is obvious, and it creates a coordination problem. Banks worry about deposit outflows and implementation costs estimated at €4 to 5.8 billion. There is no guaranteed parliamentary majority for the legislation. And Trump’s anti-CBDC stance, including signing the GENIUS Act for stablecoins while banning federal CBDCs, creates a strange dynamic where Europe might pursue a digital euro partly as a response to American policy that explicitly rejects the concept.

My read is that the digital euro and Wero are less complementary than they are competing bets on the same thesis: that Europe needs sovereign payment infrastructure. The digital euro is the maximalist version. Wero is the pragmatic one. If I had to bet, I would bet on the pragmatic version arriving first and capturing enough transaction volume to make the digital euro’s incremental value harder to justify politically. But both could fail. And both failing would leave Europe exactly where it started, which is the outcome Visa and Mastercard are quietly optimizing for.

What’s next

The next 18 months are decisive. Cross-border P2P payments through the EuroPA hub launch in 2026. E-commerce expansion to France and Belgium follows in the second half of the year. Cross-border e-commerce and point-of-sale payments via the hub are targeted for 2027. iDEAL’s full migration to Wero should complete by end of 2027.

The biggest risk is not technology or regulation. It is consumer inertia. Wero has 47 million users, but Mastercard alone has over 900 million branded cards in EU circulation. Credit cards offer credit facilities, rewards programs, and purchase protection that Wero currently cannot match. German adoption has been notably sluggish: despite being the first launch country, Germany accounts for only 5% of Wero’s transaction volume, with France dominating thanks to its Paylib migration. Dutch merchants have pushed back on the shift from iDEAL’s flat €0.29 per transaction to Wero’s percentage-based model.

I think the outcome depends on whether European policymakers treat this as a market initiative or a strategic infrastructure project. If it is the former, the cost advantages may not be enough to overcome switching costs and consumer habit. If it is the latter, and if governments are willing to subsidize adoption the way they subsidize defense procurement, then the math works. The 130-million-user network created by the EuroPA deal gives Wero something no previous European payment initiative has achieved: a user base large enough to force merchant adoption through sheer volume. Whether that is enough depends on a political question, not a technical one.

The $24 trillion figure in the headline refers to Visa and Mastercard’s combined global transaction volume. Europe’s share is roughly $4.7 trillion. Even capturing 10% of that would be a major rewiring of European payment infrastructure. The infrastructure arbitrage is real. The spread between card network fees and SEPA Instant costs is measurable and persistent. The question is execution, and execution in Europe is always the question.

Britain's Strategic Limbo

me@philippdubach.com (Philipp D. Dubach) — Wed, 28 Jan 2026 00:00:00 +0000

The UK is the country with no bloc.

At Davos, Britain refused to join Trump’s Board of Peace, citing commitment to international law and rejection of the “pay-to-play” model. France, Germany, Sweden, Norway made the same choice. The difference is that those countries have somewhere else to go. Britain doesn’t.

The SAFE instrument, the EU’s €150 billion fund for joint defense procurement, is designed explicitly for strategic autonomy. Strict “Buy European” provisions limit non-EU subcontractors to 15-35% of contract value, phased out within two years. Canada, remarkably, negotiated access and now has preferential treatment on par with EU firms. The UK remains excluded.

Talks broke down in late 2025. London viewed the EU’s requirements for third-country participation as an infringement on sovereignty. The same sovereignty concerns that drove Brexit now lock Britain out of the emerging European defense architecture. The “mid-Atlantic bridge” was always a metaphor. Britain positioned itself as the hinge between American power and European integration, useful to both, dependent on neither. That positioning assumed both poles wanted a bridge. Now the US treats allies as protection rackets and the EU is building walls around its defense industrial base. The bridge has nowhere to land.

What does the Starmer government do? The choices were supposed to be theoretical. Align with Washington and accept the transactional terms of the Donroe Doctrine. Align with Brussels and accept the sovereignty constraints of SAFE participation. Or go it alone, with a defense budget that can’t sustain independent capability against peer competitors.

The IISS analysis of SAFE’s implications for non-EU suppliers is blunt: firms outside the bloc face structural disadvantages that compound over time. Procurement cycles last decades. If British defense firms are locked out of European contracts now, the gap widens with each passing year. The industrial base erodes.

“Global Britain” was the slogan after Brexit, a vision of nimble bilateral relationships unconstrained by Brussels bureaucracy. The reality is that global influence requires either hard power or bloc membership. Britain has neither the military budget for the former nor the political will for the latter.

Canada’s pivot is instructive. Facing similar pressure from Washington, Carney diversified, joining SAFE, negotiating with Beijing, building horizontal coalitions with other middle powers. Britain has done none of this. It refused the Board of Peace on principle but hasn’t found an alternative structure to join on pragmatism.

Principles without alternatives is just isolation. The UK is learning what it means to be a middle power without a coalition, morally opposed to the new American order but structurally excluded from the European one.

The Rise of Middle Power Realism

me@philippdubach.com (Philipp D. Dubach) — Tue, 27 Jan 2026 00:00:00 +0000

At Davos 2026, Canadian Prime Minister Mark Carney delivered a speech that received something rare at these gatherings: a standing ovation. Carney told the assembled elites what they already knew but hadn’t said aloud: the world is not in a “transition” but a “rupture.”

The speech drew on Václav Havel’s 1978 essay The Power of the Powerless, specifically the parable of the greengrocer who displays the slogan “Workers of the World, Unite!” in his shop window. The grocer doesn’t believe the slogan. He displays it to signal submission, to live in harmony with the regime. Carney’s application was pointed: for years, US allies have displayed the signs of the liberal international order, pretending the partnership was mutual, that rules mattered, that values were shared. Even as reality diverged.

“It is time for companies and countries to take their signs down.”

What followed the speech was more interesting than the speech itself. Days later, Canada became the first non-European G7 nation to join the EU’s SAFE defense initiative, a €150 billion fund for joint European defense procurement. Canadian firms now have preferential access to the European defense market, treated on par with EU companies. Days before Davos, Carney had traveled to Beijing to secure a preliminary trade agreement on electric vehicles, 49,000 units at 6.1% tariff, compared to the 100% tariff the US imposes.

The intellectual framework Carney articulated has a name now: “middle power realism.” It’s built on three observations.

(1) The US is no longer a reliable partner. Not because of Trump specifically, but because American politics has shifted in ways that make transactional unilateralism the new baseline. The “Donroe Doctrine”, a portmanteau of “Donald” and “Monroe”, asserts American hegemony over the Western Hemisphere with a resource-driven, security-focused twist. It treats allies as protection rackets and international law as an impediment.

(2) Nostalgia is dangerous. The pre-2016 order isn’t coming back. Waiting for “normal” to return is a strategy for decline. Middle powers that don’t build domestic strength and horizontal coalitions will find themselves, as Carney put it invoking Thucydides, “on the menu.”

(3) Sovereignty requires the capacity to say no. That means diversified partnerships, even with rivals. Canada’s China deal infuriated Trump, who accused Carney of allowing a “Trojan Horse” into the continent. But from Ottawa’s perspective, the ability to trade with Beijing is precisely what makes Canadian sovereignty credible. You can’t negotiate from strength if you have no alternatives.

The European response follows similar logic. During the Greenland crisis, when Trump threatened tariffs on eight European nations and refused to rule out military force to “secure” the island, the EU threatened to deploy its Anti-Coercion Instrument against the United States. For the first time, the bloc signaled willingness to engage in a trade war with its primary security guarantor to protect the sovereignty of a member state.

The SAFE instrument itself is designed for strategic autonomy. Strict “Buy European” provisions limit subcontractors from non-EU countries to 15-35% of contract value, phased out within two years. The explicit goal is ITAR-free supply chains, defense procurement that doesn’t depend on American permission. Meanwhile, the UK, which refused Trump’s Board of Peace but remains excluded from SAFE due to post-Brexit negotiating failures, finds itself in strategic limbo. Alienated from Washington, locked out of European defense architecture, the “mid-Atlantic bridge” is collapsing.

There’s a strange inversion happening in the international system. At Davos, China positioned itself as the defender of the UN Charter, rejecting Trump’s “Board of Peace” as a parallel structure that undermines international law. The authoritarian superpower defending liberal institutions while the democratic superpower seeks to dismantle them. China benefits from a multipolar system with weak enforcement mechanisms. The US benefits from a unipolar system where it makes the rules. Middle powers benefit from rules that constrain the strong, which is why the Global South found validation in Carney’s speech. The admission that the “Rules-Based Order” was often cover for Western interests resonated with nations that experienced that hypocrisy firsthand.

The term “middle power” has always been slightly embarrassing, an admission of limits, a confession that you’re not at the top table. But there’s a realism emerging in these countries that the great powers lack. They can’t afford illusions about the international system because they don’t control it. They have to see clearly or get crushed.

Carney’s greengrocer metaphor cuts both ways. Yes, taking down the sign exposes the illusion. But it also means operating without the protection the illusion provided. The grocer who removes the slogan faces consequences. So do countries. Canada is betting it can navigate between giants, trading with China, defending alongside Europe, maintaining what leverage it has with Washington. The EU is betting it can build autonomous defense capacity fast enough to matter. Japan, Australia, and others are making similar calculations, hedging relationships that used to be taken for granted.

Big in Japan

me@philippdubach.com (Philipp D. Dubach) — Mon, 19 Jan 2026 00:00:00 +0000

Japan holds roughly $5 trillion in foreign assets. The US alone accounts for ¥342 trillion in bonds and equities.

Japanese 30-year yields sat below 1% from 2019 through early 2024. They’re now above 3%. The yield spread between developed market bonds and JGBs has collapsed from 400 basis points to roughly 100. The yen carry trade that defined Japanese institutional behavior since the 1990s, borrow cheap at home and invest abroad for yield, suddenly has added friction.

Japanese life insurers and pension funds have duration-matching obligations. If domestic yields offer adequate returns with lower currency risk, the marginal incentive to hold Treasuries weakens. GPIF, the world’s largest pension fund, doesn’t need to reach for yield in US credit markets when JGBs pay 3%.

This doesn’t mean Japanese investors dump everything tomorrow. Institutional rebalancing is glacial. Currency hedging costs matter and existing positions have different maturity profiles. Treasury market depth has deteriorated since 2020. Primary dealers hold smaller inventories. Liquidity provision is thinner. A sustained seller of size, which Japanese institutions would be, arrives into a market less equipped to absorb flow than at any point since the GFC.

The second-order effects compound. Japanese selling pressures Treasury yields higher. Higher yields strengthen the dollar near-term but raise US borrowing costs. If Japan’s repatriation triggers broader reserve manager concern about duration exposure, the feedback loop accelerates.

The consensus view remains that Japan is trapped. Any meaningful tightening implodes JGB markets where the BOJ owns half of outstanding supply. But the data suggests something else. Yields are rising, volatility is elevated, and the market is absorbing it. The trap might be less binding than assumed.

The yen carry trade unwound violently in August 2024 and the S&P dropped 6% in three days. That was positioning adjustment. Repatriation of actual assets would be slower but larger.

When a $5 trillion portfolio starts rebalancing toward domestic assets, you don’t need to predict the timing. You need to be positioned for a situation where the marginal Treasury buyer becomes a marginal seller. What happens in Japan doesn’t stay in Japan.

Repo might be even bigger than we thought

me@philippdubach.com (Philipp D. Dubach) — Tue, 13 Jan 2026 00:00:00 +0000

Finance is anthropological

That’s Zoltan Pozsar, the Hungarian-American economist who mapped the plumbing of modern money before most people knew there was plumbing to map. When he said it to Bloomberg in 2019, he was trying to explain why repo markets (the overnight lending infrastructure that lubricates trillions in daily transactions) had just seized up in ways the Federal Reserve didn’t anticipate.

I’ve written about Pozsar’s work before, particularly his “Bretton Woods III” thesis about the shifting role of the dollar. But his earlier research on shadow banking and repo markets feels increasingly relevant as we enter 2026. In December 2025, the Office of Financial Research published new data on the size of the U.S. repo market. The number: $12.6 trillion in average daily exposures. That’s roughly $700 billion larger than previous estimates; a measurement error roughly the size of the entire Swiss banking system.

Where did the extra $700 billion come from? Mostly from what the OFR calls “non-centrally cleared bilateral repo,” or NCCBR; the segment of the market that doesn’t flow through clearinghouses or the tri-party platforms that regulators can easily observe. This bilateral segment alone accounts for $5 trillion. Until the OFR’s new transaction-level data collection, which only reached full implementation in July 2025, much of this activity was essentially invisible.

This matters because repo is not a peripheral market. It is the market through which cash-rich institutions lend to cash-poor ones, every single day, against collateral. Money market funds, hedge funds, broker-dealers, asset managers, banks. When repo works, it’s invisible. When it doesn’t, as in September 2019, overnight rates spike and the Fed scrambles to inject liquidity.

On December 31, 2025, eligible financial firms borrowed a record $74.6 billion from the Fed’s Standing Repo Facility, which is the highest since its launch in 2021. The Fed had just eliminated the $500 billion daily cap on this facility, a quiet acknowledgment that the ceiling might actually matter. Quantitative tightening officially ended on December 1, 2025. Reserves had fallen to $2.8 trillion, their lowest in four years.

The plumbing was straining again.

Pozsar’s 2014 OFR paper, “Shadow Banking: The Money View,” introduced a framework that still haunts anyone who reads it carefully. At its core is a hierarchy of money. Currency sits at the top, the liability of the sovereign. Below that: bank deposits, insured and backstopped by the FDIC. Below that: repo, secured by collateral but not by any explicit government guarantee. Below that: the constant-NAV shares of money market funds, which promise par redemption but rest on layers of private credit puts, reputational commitments, and the fragile assumption that nothing will go wrong simultaneously.

The key insight is that what counts as “money” depends on where you sit in this hierarchy. For a retail depositor, money is an insured bank balance. For a corporate treasurer managing $50 billion in cash, money begins where M2 ends—in repo, in money fund shares, in instruments that offer some semblance of safety at scale but lack the explicit backstops that smaller depositors take for granted.

Pozsar called these institutions “cash pools”—the corporate treasuries, sovereign wealth funds, and asset managers whose cash balances are too large to fit within the insured deposit system. They need money-like instruments, but the supply of truly safe assets (Treasury bills, insured deposits) is inelastic. So they reach for the next best thing: shadow money claims backed by private collateral and private liquidity puts.

Now, the new OFR data reveals that $5 trillion of daily repo activity, roughly 40% of the market, occurs in bilateral arrangements that, until recently, were largely opaque to regulators. The collateral backing this activity is 61.8% Treasuries, but that leaves substantial room for corporate bonds, agency MBS, and other assets that can gap in value during stress.

Pozsar’s 2019 Global Money Notes described the repo market as a hierarchy with dealers at the center and the Fed at the top, operating as a “dealer of last resort” when private balance sheets reach their limits. The Standing Repo Facility was supposed to institutionalize this role, providing a ceiling on overnight rates by offering funding at a known price.

The facility sat unused for years while reserves were abundant. Now, as reserves decline, usage is spiking at quarter-ends and year-ends, exactly when balance sheet constraints bind hardest. The question Pozsar raised in 2019 remains unanswered: can the Fed operate a standing repo facility that polices the top of its target range without losing control over its balance sheet size? Or will it be forced, eventually, to monetize excess collateral on a scale that looks a lot like QE by another name?

There’s a concept in infrastructure studies called “seamful design”: the idea that making the seams of a system visible can improve rather than degrade the user experience. GPS, for instance, became more useful when designers surfaced uncertainty estimates rather than hiding them.

The repo market is the opposite: seamless by design, invisible until it fails. The OFR’s new data collection is, in some sense, an attempt to add seams, to make visible what was hidden, to understand the shape of the beast before the next crisis. But measurement is not control. Knowing the market is $12.6 trillion doesn’t tell you what happens when a major counterparty fails, or when a category of collateral suddenly trades at distressed prices, or when the behavioral assumptions embedded in banks’ liquidity models turn out to be wrong.

Pozsar understood this intuitively. His famous map of the shadow banking system, posted in the New York Fed’s briefing room, required zooming in seven or eight times to read any detail. Colleagues who didn’t take the time to study it, he warned, were looking at “10% of the picture.”

Pozsar's Bretton Woods III: Three Years Later [2/2]

me@philippdubach.com (Philipp D. Dubach) — Sun, 26 Oct 2025 00:00:00 +0000

Start by reading Pozsar’s Bretton Woods III: The Framework [1/2]

Now, what actually happened in the three years since Pozsar published the Bretton Woods III framework? (1) Dollar reserve diversification is happening, but gradual: Foreign central bank Treasury holdings declined from peaks exceeding $7.5 trillion to levels below $7 trillion. This represents steady diversification away from dollar-denominated assets, though not a dramatic collapse. (2) Gold has performed strongly: From roughly $1'900/oz when Pozsar published his dispatches to peaks above $4'000/oz today, gold has appreciated substantially, consistent with increased central bank gold buying and demand for “outside money.” (3) Alternative payment systems are developing: Various nations continue building infrastructure for non-dollar trade settlement. While these systems remain in preliminary stages rather than fully operational alternatives to SWIFT, development timelines could speed up following specific triggering events. (4) The dollar itself has remained strong: Perhaps surprisingly given predictions of reserve currency decline, the dollar achieved its best performance against a basket of major currencies since 2015 in 2024. The DXY index (which tracks the dollar against major trading partners) fell about 11% this year, marking the end of this decade-long rally. (5) Commodity collateral is increasingly important: Research on commodities as collateral shows that under capital controls and collateral constraints, investors import commodities and pledge them as collateral. Higher collateral demands increase commodity prices and affect the inventory-convenience yield relationship.

China’s Strategic Options in Bretton Woods III

One of Pozsar’s more provocative arguments concerns China’s strategic options. With approximately $3 trillion in foreign exchange reserves heavily weighted toward dollars and Treasuries, China faces the same calculus as any holder of large dollar reserves: what is the risk these could be frozen? Pozsar outlined two theoretical paths for China: (1) Sell Treasuries to purchase commodities directly (especially discounted Russian commodities), thereby converting financial claims into physical resources. (2) Print renminbi to purchase commodities, creating a “eurorenminbi” market parallel to the eurodollar system.

The first option provides inflation control for China (securing physical resources) while potentially raising yields in Treasury markets. The second option represents a more fundamental challenge to dollar dominance, the birth of an alternative offshore currency market backed by commodity reserves rather than financial reserves. In practice, we’ve seen elements of both. China has increased commodity imports from Russia substantially. The internationalization of the renminbi has progressed, though more slowly than some expected, constrained by China’s capital controls and the relative underdevelopment of its financial markets compared to dollar markets.

Durable Insights from the Bretton Woods III Framework

Regardless of whether Bretton Woods III emerges exactly as described, several insights from Pozsar’s framework appear durable. (1) Central banks control the nominal domain, not the real domain: Monetary policy can influence demand, manage liquidity, and stabilize financial markets. It cannot conjure physical resources, build supply chains, or speed up energy transitions. This distinction matters most during periods of supply-driven inflation, when rate hikes do little to resolve the underlying commodity shortage. (2) Physical infrastructure matters for financial markets: The number of VLCCs, the capacity of the Suez Canal, the efficiency of port facilities, these real-world constraints bind financial flows. Understanding the infrastructure underlying commodity movements provides insight into funding market dynamics. (3) Collateralization is changing: The trend toward commodity-backed finance, warehouse receipt systems, and physical collateral reflects both technological improvements (better monitoring and verification) and strategic shifts (diversification away from pure financial claims). As the FSB noted in 2023, banks play a vital role in the commodities ecosystem, providing not just credit but clearing services and intermediation between commodity firms and central counterparties. (4) Geopolitical risk affects monetary arrangements: The weaponization of reserve assets, however justified in specific circumstances, changes the risk calculation for all reserve holders. This doesn’t mean immediate de-dollarization, but it does mean persistent, gradual reserve diversification.

Practical Implications for Funding Markets and Monetary Policy

So what can we take from this for today: (1) Funding market stresses may be more persistent: If commodity traders require more financing for longer durations due to less efficient trade routes, and if banks face balance sheet constraints from regulatory requirements or QT, term funding premia may remain elevated relative to overnight rates. The FRA-OIS spread, the spread between forward rate agreements and overnight indexed swaps, becomes a window into these dynamics. (2) Cross-currency basis swaps signal more than rate differentials: Persistent deviations from covered interest parity reflect structural factors: global trade reconfiguration, reserve diversification, and the changing geography of dollar funding demand. These aren’t temporary anomalies to be arbitraged away but potentially persistent features of the new monetary system. (3) Commodity volatility has monetary policy implications that are difficult to manage: When commodity prices surge due to supply disruptions rather than demand strength, central banks face an ugly tradeoff: tighten policy to control inflation headlines while risking recession, or accommodate the price shock and accept higher inflation. Unlike demand-driven inflation, supply-driven commodity inflation doesn’t respond well to rate hikes. (4) Infrastructure bottlenecks matter: Just as G-SIB constraints around year-end affect money market functioning, shipping capacity constraints and logistical bottlenecks affect commodity prices and, through them, inflation. Monitoring the “real plumbing,” freight rates, port congestion, pipeline capacity, provides early warning signals for inflation pressures.

Bretton Woods III as an Analytical Framework

Perhaps the most valuable way to engage with Bretton Woods III is not as a prediction to be validated or refuted, but as a framework for thinking about the intersection of geopolitics, commodities, and money. It forces attention to questions that are easy to overlook: (a) How do physical constraints on commodity flows affect financial market plumbing? (b) What risks do reserve holders face that aren’t captured in traditional financial risk metrics? (c) Where do central bank powers end and other forms of power, military, diplomatic, infrastructural, begin? (d) How do the “real” and “nominal” domains interact during periods of stress?

The current environment shows elements consistent with the Bretton Woods III framework: gradual reserve diversification, persistent commodity volatility, funding market stresses related to term commodity financing, and increasing focus on supply chain resilience over pure efficiency. It also shows elements inconsistent with it: dollar strength through 2024, the slow pace of alternative payment systems, and the resilience of dollar-based financial infrastructure. What seems clear is that the assumptions underlying Bretton Woods II, that dollar reserves are nearly risk-free, that globalized supply chains should be optimized for cost above all else, that central banks can manage most monetary disturbances, are being questioned in ways they weren’t five years ago. Whether that questioning leads to a new monetary order or simply a modified version of the current one remains to be seen. But Pozsar’s framework provides a useful lens for watching the process unfold, connecting developments in commodity markets, funding markets, and geopolitical arrangements into a coherent story about how the global financial system actually works.

Pozsar’s full Money Notes series is available through his website, and Perry Mehrling’s course Economics of Money and Banking provides excellent background on the “money view” that underpins this analysis.

Pozsar's Bretton Woods III: The Framework [1/2]

me@philippdubach.com (Philipp D. Dubach) — Sat, 25 Oct 2025 00:00:00 +0000

In March 2022, as Western nations imposed unprecedented sanctions following Russia’s invasion of Ukraine, Zoltan Pozsar published a series of dispatches that would become some of the most discussed pieces in financial markets that year. The core thesis was stark: we were witnessing the birth of “Bretton Woods III,” a fundamental shift in how the global monetary system operates. Nearly three years later, with more data on de-dollarization trends, commodity market dynamics, and structural changes in global trade, it’s worth revisiting this framework.

I first heard of Pozsar at Credit Suisse during the 2019 repo market disruptions and the March 2020 funding crisis, when his framework explained market dynamics in a way I have never seen it before. Before joining Credit Suisse as a short-term rate strategist, Pozsar spent years at the Federal Reserve (where he created the map of the shadow banking system, which prompted the G20 to initiate regulatory measures in this area) and the U.S. Treasury. His work focuses on what he calls the “plumbing” of financial markets, the often-overlooked mechanisms through which money actually flows through the system. His intellectual approach draws heavily from Perry Mehrling’s “money view,” which treats money as having four distinct prices rather than being a simple unit of account.

Inside Money, Outside Money, and the Reserve Currency Shift

Pozsar’s Bretton Woods III framework rests on a straightforward distinction. “Inside money” refers to claims on institutions: Treasury securities, bank deposits, central bank reserves. “Outside money” refers to commodities like gold, oil, wheat, metals that have intrinsic value independent of any institution’s promise.

Bretton Woods I (1944-1971) was backed by gold, outside money. The U.S. dollar was convertible to gold at a fixed rate, and other currencies were pegged to the dollar. When this system collapsed in 1971, Bretton Woods II emerged: a system where dollars were backed by U.S. Treasury securities, inside money. Countries accumulated dollar reserves, primarily in the form of Treasuries, to support their currencies and facilitate international trade.

Pozsar’s argument: the moment Western nations froze Russian foreign exchange reserves, the assumed risk-free nature of these dollar holdings changed fundamentally. What had been viewed as having negligible credit risk suddenly carried confiscation risk. For any country potentially facing future sanctions, the calculus of holding large dollar reserve positions shifted. Hence Bretton Woods III: a system where countries increasingly prefer holding reserves in the form of commodities and gold, outside money that cannot be frozen by another government’s decision.

Perry Mehrling’s Four Prices of Money

To understand Pozsar’s analysis, we need to understand his analytical framework. Perry Mehrling teaches that money has four prices: (1) Par: The one-for-one exchangeability of different types of money. Your bank deposit should convert to cash at par. Money market fund shares should trade at $1. When par breaks, as it did in 2008 when money market funds “broke the buck,” the payments system itself is threatened. (2) Interest: The price of future money versus money today. This is the domain of overnight rates, term funding rates, and the various “bases” (spreads) between different funding markets. When covered interest parity breaks down and cross-currency basis swaps widen, it signals stress in the ability to transform one currency into another over time. (3) Exchange rate: The price of foreign money. How many yen or euros does a dollar buy? Fixed exchange rate regimes can collapse when countries lack sufficient reserves, as happened across Southeast Asia in 1997. (4) Price level: The price of commodities in terms of money. How much does oil, wheat, or copper cost? This determines not just headline inflation but feeds through into the price of virtually everything in the economy.

Central banks have powerful tools for managing the first three prices. They can provide liquidity to preserve par, influence interest rates through policy, and intervene in foreign exchange markets. But the fourth price, the price level, particularly when driven by commodity supply shocks, is far harder to control. As Pozsar puts it: “You can print money, but not oil to heat or wheat to eat.”

Commodity Plumbing: From Financial Domain to Real Domain

Pozsar’s contribution was to extend Mehrling’s framework into what he calls the “real domain,” the physical infrastructure underlying commodity flows. For each of the three non-commodity prices of money, there’s a parallel in commodity markets: (1) Foreign exchange ↔ Foreign cargo: Just as you exchange currencies, you exchange dollars for foreign-sourced commodities. (2) Interest (time value of money) ↔ Shipping: Just as lending has a time dimension, moving commodities from port A to port B takes time and requires financing. (3) Par (stability) ↔ Protection: Just as central banks protect the convertibility of different money forms, military and diplomatic power protects commodity shipping routes.

This mapping reveals something important: commodity markets have their own “plumbing” that works parallel to financial plumbing. And when this real infrastructure gets disrupted, it creates stresses that purely monetary policy cannot resolve.

Sanctions, Shipping, and the Commodity Financing Bottleneck

One of the most concrete examples in Pozsar’s March 2022 dispatches illustrates this intersection between finance and physical reality. Consider what happens when Russian oil exports to Europe are disrupted and must be rerouted to Asia. Previously, Russian oil traveled roughly 1-2 weeks from Baltic ports to European refineries on Aframax carriers (ships carrying about 600,000 barrels). The financing required was relatively short-term, a week or two. Post-sanctions, the same oil must travel to Asian buyers. But the Baltic ports can’t accommodate Very Large Crude Carriers (VLCCs), which carry 2 million barrels. So the oil must first be loaded onto Aframax vessels, sailed to a transfer point, transferred ship-to-ship to VLCCs, then shipped to Asia, a journey of roughly four months.

The same volume of oil, moved the same distance globally, now requires: (a) More ships (Aframax vessels for initial transport plus VLCCs for long-haul). (b) More time (4 months instead of 1-2 weeks). (c) More financing (commodity traders must borrow for much longer terms). (d) More capital tied up by banks (longer-duration loans against volatile commodities).

Pozsar estimated this rerouting alone would encumber approximately 80 VLCCs, roughly 10% of global VLCC capacity, in permanent use. The financial implication: banks’ liquidity coverage ratios (LCRs) increase because they’re extending more term credit to finance these longer shipping durations. When commodity trading requires more financing for longer durations, it competes with other demands for bank balance sheet. If this happens simultaneously with quantitative tightening (QT), when the central bank is draining reserves from the system, funding stresses become more likely. As Pozsar noted: “In 2019, o/n repo rates popped because banks got to LCR and they stopped lending reserves. In 2022, term credit to commodity traders may dry up because QT will soon begin in an environment where banks’ LCR needs are going up, not down.”

Dollar Funding Vulnerabilities for Non-U.S. Banks

One aspect of the framework that deserves more attention relates to dollar funding for non-U.S. banks. According to recent Dallas Fed research, banks headquartered outside the United States hold approximately $16 trillion in U.S. dollar assets, comparable in magnitude to the $22 trillion held by U.S.-based institutions. The critical difference: U.S. banks have access to the Federal Reserve’s emergency liquidity facilities during periods of stress. Foreign banks do not have a U.S. dollar lender of last resort. During the COVID-19 crisis, the Fed expanded dollar swap lines to foreign central banks precisely to address this vulnerability, about $450 billion, roughly one-sixth of the Fed’s balance sheet expansion in early 2020. The structural dependency on dollar funding creates ongoing vulnerabilities. When dollars become scarce globally, whether due to Fed policy tightening, shifts in risk sentiment, or disruptions in commodity financing, foreign banks face balance sheet pressures that can amplify stress. The covered interest parity violations that Pozsar frequently discusses reflect these frictions: direct dollar borrowing and synthetic dollar borrowing through FX swaps theoretically should cost the same, but in practice, significant basis spreads persist.

Continue reading Pozsar’s Bretton Woods III: Three Years Later [2/2]

Dual Mandate Tensions

me@philippdubach.com (Philipp D. Dubach) — Wed, 21 May 2025 00:00:00 +0000

Something interesting just happened at the National Bureau of Economic Research NBER

We study the optimal monetary policy response to the imposition of tariffs in a model with imported intermediate inputs. In a simple open-economy framework, we show that a tariff maps exactly into a cost-push shock in the standard closed-economy New Keynesian model, shifting the Phillips curve upward. We then characterize optimal monetary policy, showing that it partially accommodates the shock to smooth the transition to a more distorted long-run equilibrium—at the cost of higher short-run inflation.

Here’s where it gets interesting for current policy: Werning et. al. show that “optimal” monetary policy would actually calls for partial accommodation of tariff shocks—essentially allowing some inflation to persist to smooth the transition to what they euphemistically call “a more distorted long-run equilibrium.” With core PCE still running above the Fed’s 2% target and renewed tariff threats on the horizon, this research suggests Powell may need to abandon his recent dovish pivot and prepare for rate hikes that prioritize price stability over employment concerns. The dual mandate was never meant to be dual when the two mandates point in opposite directions.