Long-term, broad-based economic growth is the goal, and the Fed alone cannot deliver it.
Long-term, broad-based economic growth is the goal, and the Fed alone cannot deliver it.
E arlier this month, the Federal Reserve cut interest rates by half a percentage point in a bid to avert a recession. The cut is made more notable by the first dissent from a Fed governor in nearly 20 years, with Michelle Bowman voting instead for a quarter-percentage-point cut. This dissent is a welcome development. Increasingly, the Fed has seemed captured by groupthink from dovish economists and financial-market economists who yearn for a return to an easy monetary policy that juices asset prices despite the risk of inflation roaring back.
Pundits and economists debate to what extent the early-2020s inflation was attributable to reckless fiscal policy and supply-chain issues but often forget that groupthink brought us an avoidable rise in inflation. It was clear by the autumn of 2021 that the inflation spike, which began in the spring of 2021, wasn’t a “transitory” phenomenon, yet Wall Street forecasters, academic economists, business journalists, and the Fed continued to downplay the risk of inflation. The annual inflation rate had reached a 40-year high of 8 percent when the central bank finally raised rates in March 2022.
The new groupthink, which insists on cutting rates as much and as soon as we can, carries a risk for those not buoyed by inflated asset prices. Even as inflation has declined, it remains a half percentage point higher for the bottom quartile of the income distribution, something we have documented in our research with the Foundation for Research on Equal Opportunity. If inflation spikes again, low-income households would be disproportionately hurt because the prices for the “basket” of goods that those families buy would rise faster than the goods typically purchased by higher-income households.
Just as the Fed was behind the curve with inflation in 2021, the central bank now fears being behind the curve of a potential recession. This fear cracks the façade of confidence that the Fed projects in its all-too-frequent public communications. Is monetary policy so much better now than when Volcker and Greenspan let the central bank’s actions speak for themselves?
The Fed’s dramatic announcements together with financial markets’ hanging on Chairman Powell’s every word create a vicious cycle of short-termism in which we live from announcement to announcement. This is like trying to drive a car by staring at the speedometer instead of down the road.
It is exactly the excessive focus on the Fed that causes the groupthinkers and permadoves to forget an important lesson: Long-term, broad-based economic growth is the goal, and the Fed alone cannot deliver it. Productivity gains — through technology and the regulatory and tax policies that incentivize them — are what drive growth. Stable monetary policy is helpful, but monetary policy cannot be stable if we hang on every word of unnecessary press conferences.
For those who think that low interest rates are the solution to our growth problems, look at Europe and Japan, where decades of zero- or negative-interest-rate policy failed to revive GDP growth. Europe’s dimming economic prospects demonstrate that low interest rates are no match against the stifling effects of regulatory policies such as the General Data Protection Regulation and the Corporate Sustainability Due Diligence Directive, a recent EU mandate that requires companies to audit their entire supply chains and reshape business operations to fall in line with Europe’s emissions targets.
Mario Draghi’s recent report on the productivity malaise in Europe and what to do about it is a wake-up call from a former head of the European Central Bank.
Although Draghi’s favored policy prescriptions — decarbonization and massive state investments in digital technology — are unlikely to ignite the EU’s stagnant economy, it’s striking that the former European Central Bank head isn’t emphasizing low interest rates as a solution to the bloc’s tepid growth. If the U.S. doesn’t get serious about growth soon, it could — who knows? — be former Federal Reserve officials who end up leading commissions that tell us we should have been focusing on productivity all along and not obsessing about our central bankers’ every maneuver.
In the meantime, the Fed should stop talking, start working, be honest about its limitations, and confront its groupthink problem.
Jon Hartley is a senior fellow at the Macdonald-Laurier Institute, a research fellow at the Foundation for Research on Equal Opportunity, and an economics Ph.D. candidate at Stanford University. He is also the host of the Capitalism and Freedom in the 21st Century podcast at the Hoover Institution. Jackson Mejia is an economics Ph.D. student at MIT and a visiting fellow at the Foundation for Research on Equal Opportunity. Michael Toth is a resident fellow at the Foundation for Research on Equal Opportunity and a founding partner of PNT Law.