Fed Makes Mistakes

The Fed Compounds Its Mistakes – Allan Meltzer, The Wall Street Journal
“The Federal Reserve seems determined to make mistakes…Anyone can make a mistake, but wise people don’t repeat the same one. Increasing inflation to reduce unemployment initiated the Great Inflation of the 1960s and 1970s…The most important restriction on investment today is not tight monetary policy, but uncertainty about administration policy. Businesses cannot know what their taxes, health-care, energy and regulatory costs will be, so they cannot know what return to expect on any new investment…The only lasting solution for housing is to let prices fall to a new equilibrium. Painful, yes, but necessary. Temporary palliatives such as lower interest rates delay that adjustment…Once the economy does begin to heat up, the Fed will urgently need to reduce excess bank reserves lest they stoke inflation. The Fed has talked about policies it can use to do so, such as raising the interest rates it pays to banks to hold their reserves. It has not offered a coherent, credible program to do so since it does not say, and probably does not know, how high the market interest rate would have to be…Adverse public reaction to higher interest rates has stopped anti-inflation policy many times in the past…Or will interest rates rise, pushed up by a flight from government bonds? That’s a risk that does not seem to bother many. Not yet, but it should, and it will…One of the main reasons offered by some Fed governors and market portfolio managers for more stimulus is the fear of deflation. Yet the annual rate of increase in the consumer price index has remained between 1.2% and 2.5% every month this year. No evidence of deflation there. In fact, the Fed’s inflation target is said to be between 1% and 2%, just about where it is…The fear of mild deflation is another mistake, one commonly made. In the almost 100 years of Federal Reserve history, periods when prices declined over several months have occurred seven times. Sometimes the deflation reached 30%, yet the recoveries that followed six of the deflations cannot be distinguished from any other post-recession recovery…Countries with a depreciating exchange rate, an unsustainable budget deficit, and more than $1 trillion of excess monetary reserves are more likely to inflate.”