Gradualism turned out to be a mistake

By the end of 2021, Fed officials realized they had made a mistake, allowing aggregate demand to grow at an excessive rate. They began to move towards tightening monetary policy. Unfortunately, they moved so slowly that almost no tightening was done in the first nine months of 2021. They are worried about the scary market. It was a big mistake.

As inflation accelerates as early as 2022, the Fed is content to let short-term rates stay close to zero. What the Fed did was change from “not thinking about raising rates” to “thinking about raising rates”. Many Fed watchers mistakenly thought this represented tightening. In mid-March, they raised rates by a measly quarter point, too little to slow the relentless rise in core inflation. The policy was still expansionary. And yet many pundits think the Fed overreacted, moving too aggressively.

Now we are going to pay the price of Fed gradualism. Bloomberg Just suggested that there is a 100% chance of a recession next year. I think it’s too high, but the risk is clearly increasing. By not tightening aggressively at the end of 2021, the Fed allows inflation to creep deeper into the economy. Even with core inflation rising now, the pain involved in bringing it down will be high. A smaller recession in 2022 would have been better than a bigger recession in 2023.

As Matt Yglesias likes to say, if the Fed expects to gradually raise rates by 200 or 300 basis points over the next year, it should probably do so now. It’s like stepping into a cold lakeā€”just jump in; Do not wade in an inch at a time.

The Fed needs to stop worrying about scaring the market and focus on their core responsibilities. In the long run, the worst thing that can happen to the market is a bad macroeconomics. Fix the economy and the markets will follow. Markets like stable NGDP growth.

Rest assured. Just to be clear, persistence was not the Fed’s primary flaw. The biggest mistake was abandoning the policy of average inflation targeting. This is what allowed inflation to accelerate in the first place. A massive unforced error, which seriously damaged the Fed’s credibility.

PPS. guardian Despite 9.5% NGDP growth in the past year, the problem is supply-side inflation:

“Raising interest rates is not working, and the Fed’s overly aggressive actions are pushing our economy to the brink of a devastating recession,” said Rakin Mabud, chief economist at the progressive Groundwork Collaborative think tank. “Supply chain disruptions, a volatile global energy market and massive corporate profiteering cannot be solved by excessive rate hikes.”

The Fed and some economists maintain that a hot labor market and high wages drive inflation and counteract the demand created by high unemployment and interest rates. . . .

Current inflation is not primarily demand- or labor-driven as it often is during deflation, says Claudia Sahm, a former Fed economist and founder of Sahm Consulting.

“High inflation is not the fault of workers, but the Fed is waging war on US workers,” Sahm said.

I’m not sure I’d call the lowest unemployment rate in 53 years a “war on American workers.”

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