The US Federal Reserve must do two things right now
Subscribe to enjoy similar stories. As US Federal Reserve officials deliberate monetary policy, they may wish to recall what happened when policymakers in past decades became overconfident in using demand management measures to ‘fine tune’ the economy. The lesson learnt is that, apart from threats of high inflation at one end and recessions or balance-sheet implosions at the other, it is better to maintain a steady policy rather than react to every data point.
The time has come for the Fed to internalize this lesson. Policymakers grew confident at the end of the 20th century that fiscal and monetary policies could deliver a ‘great moderation.’ Some went as far as to suggest that they had “conquered the business cycle." This overconfidence in ‘fine tuning’ the economy arises from a misunderstanding of Keynes’s insights into the workings of the demand side of the economy, as summarized in his 1936 The General Theory of Employment, Interest Rates and Money. It was a policy phenomenon that oversimplified Keynes’ critical insights.
And it was again blown apart by a series of disruptive events, quite a few of which were caused by a lack of humility. The alternative for policymaking was to substitute overconfidence in fine tuning based on high frequency data with a preference for steady and sustainable policy postures. This was accompanied by greater emphasis on the supply side, particularly the factors impacting productivity, investment and growth.
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