Federal Reserve Folly

Federal Reserve Folly

Great news: The US economy is officially out of recession. We know this because the National Bureau of Economic Research’s official recession-calling committee said so this week. The economy has been in an expansion phase since last April, making this the shortest recession on record at only two months.

The NBER committee always makes these calls in hindsight—both the beginning and end of recessions. Literally everyone could see the economy coming to a halt in March and April. The signs weren’t subtle. Yet it wasn’t until June 8, 2020, that they said the economy had peaked in February, marking the recession’s onset. I don’t blame them for waiting to see the data, though. Caution is appropriate on these things.

But really, 15 months to affirm the economy has been expanding? Their statement was quite specific. They call April 2020 the bottom because that month showed clear troughs in unemployment, GDP, PCE, and personal income ex-transfers. All this was known long ago.

Unlike NBER, a private group with no formal power, the Federal Reserve can actually do something with this kind of information. Nor does the Federal Open Market Committee have to wait for confirmation. It can act whenever it sees a need, which it certainly did when the pandemic struck.

Here’s a handy timeline summarizing the Fed’s near-daily actions in March and April 2020. They did far more than just open the Quantitative Easing spigots ($120 billion a month and counting) and lower the Fed Funds rates to zero.

Source: AAF

As I said back then, the Fed’s dramatic response (accompanied by the federal government’s equally dramatic fiscal response) was appropriate given what was known at the time. It was an unprecedented situation, potentially threatening the economy and financial system’s core stability. They had to act quickly and aggressively.

Where we can/should blame Fed leadership, though, is in the failure to recognize the time to slowly end the extraordinary measures, which are now having extraordinary and harmful side effects. Today I want to describe what is happening and tell you what I think the Fed should do. Though, to be frank, I have little hope they will.

Let me be very clear. I believe the Federal Reserve has already made a significant policy error that can lead directly to recession. An accompanying fiscal policy error by the US Congress could compound the Fed’s error, although that remains to be seen, as it is not clear what will pass Congress.

Unneeded Fire Trucks

I greatly admire the skill and bravery of firefighters. I once had the personal benefit of their help (recounted here) and was glad they came.

In watching how firefighters work, I have noticed some patterns. When notified of an emergency like a high-rise fire, which could be either very serious or a mild annoyance, they assume the worst. They arrive quickly and in force. Once on-scene, they decide exactly what is needed and the chief then either calls for reinforcements or releases the extra capacity to go elsewhere. But they initially bring it all “just in case.” This is prudent when lives may be at stake.

What they don’t do is stay on the scene in full force once the emergency is over. Of course, large fires can smolder for days. They might leave a small crew to extinguish any flare-ups but they won’t tie up the entire department when it may be needed elsewhere.

Now imagine the Federal Reserve is our financial fire department. It got a 12-alarm call in March 2020 and rolled out every truck it had. That was the right response. But within a few months, or at most a few quarters later, it was clear the Fed’s part of the emergency was over.

COVID-19 wasn’t over, of course (and still isn’t), nor was the economy in a great position. But the systemic meltdown risk had passed. The fire was still smoldering, but at that point, it was mainly a fiscal fire.

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William K. 1 month ago Member's comment

The Federal Reserve has been making "significant policy errors" for many years, most of them fairly obvious. So while this time it has done faster damage, which looks a little different, the damage continues. We might be doomed.

William K. 1 month ago Member's comment

This is indeed disturbing, mostly for being correct.

Who does inflation injure? That is simple to answer. Inflation injures ALL who are not able to easily increase their incomes or their assets that hey are needing to live on. That seems to include the bottom 80% of the population. it certainly includes ME!

Perhaps holding those in the federal reserve personally responsible for the results of their actions would be a start toward correcting the problem. That means they would have NO Protection against legal judgements. A lack of armor often slows down a warrior, and encourages careful thought.