The past two and a half years have been extraordinary. The unnerving combination of a global pandemic exacerbated by energy scarcity, supply chain disruptions, the return of inflation, rising multipolar geopolitical tensions, and a new monetary era have people wondering what certainties are left. Still, in times of rapid change, it’s nice to know that some things stay the same.
Take The Federal Reserve for an example. The Fed does not learn from its mistakes. The Fed lost control of the money supply, causing inflation to soar. In the two years following the March 2020 COVID-induced recession, the Fed allowed the broad money supply to expand by a staggering 40%.
It did so by keeping its policy rate at its zero-lower bound and increasing the size of its balance sheet by almost $5 trillion through its aggressive purchases of Treasury bonds and mortgage-backed securities.
In 2021, not hemming and hawing, the Fed kept assuring the American public that the inflation they were experiencing was a transitory phenomenon. The Fed lost much credibility by failing to acknowledge inflation was surging back in 2021 and it is not obvious it has rebuilt its reputation. This despite warnings that the explosion in money supply growth would take the country back to the inflation of the 1970s.
Not to forget, the Fed effectively pursued a policy of zilch interest rates or free money for 14 years since the 2008 financial crisis. Individuals and institutions happily adapted to a universe in which money was practically free. They forgot that free money turns out to be expensive. By failing to return the price of credit to something normal the Fed was fueling greater risk taking.
A sign of an intelligent mind is learning from one’s mistakes. This is not the case with the Fed. The technocrats, the boffins, and the cognitive elites didn’t know what they were doing. Worse than not knowing what they were doing, Americans suffered big declines in disposable incomes over long period as a result of their policy choices. The economy did not deliver to the great majority of Americans the sort of life they wanted and hoped for.
People bought houses they could only afford with tiny interest payments, companies borrowed to buy back their own shares, investors borrowed to buy stock in a can’t lose stock market, and politicians ran up national debts whose servicing was only possible if interest rates remained negligible forever, putting the country on an unsustainable fiscal trajectory.
Then in 2022, the wise men at the Fed started raising interest rates at the fastest pace in half a century: 500 basis points in pursuit of lower inflation. That is a lot to cram through the economy in a year and something just might break. And it did. March madness was the appropriate tag line applied to last month’s scare provoked by the collapse of three U.S. banks as a result of rate hikes poor management, and the abject failure of regulators.
Of course, none of this would have been necessary had the Fed started tightening monetary policy a year earlier. The inflation was not transitory. It’s a bitter solace to savers that they can earn a meager say, 4.5 percent interest on their savings only now that, inflation being so high, that their funds on an inflation adjusted basis are still losing value and adding to the cost of living crisis for the ordinary American.
Ushering back in a new era of cheap money is by no means a requirement but would be a tempting one at that given how addicted to mass spending everyone has become. But that if the Fed has learned anything would have serious repercussions.
Looking forward it may well be that in God’s newly automated earth, AI will offer a precious escape from the problem of setting interest rates, avoiding the friction and stress and politics which accompanies developing monetary policy. Just as the intelligent ChatGPT is churning out poetry better than Milton, surely this new technology can design, plan, and execute monetary policy in the future. They are becoming quite good at that.