Fed Spikes the Punch Again

Last week the Federal Reserve’s Open Market Committee publicized its decision to keep the key policy interest rate – the federal funds rate – at a historic low “for some time.”

The announcement said: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.”

Such policy follows from the Fed’s double goal of low unemployment and inflation. Since there is still an overhang of unemployment while inflation is below target, it makes sense to continue expansionary monetary policy.

We do not know what long-term effects this will have, but the logic is similar to that behind previous easy money policies. Those had unintended consequences in asset markets, encouraging irrational exuberance in stocks (late 1990s) and later in credit and housing (2000s). Here is the crux of the issue, from Ponzi Regulation:

“You will recall that one rationale for financial regulation is to protect people against their own cognitive shortcomings. The 1990s and 2000s showed that reasoning to be false. As irrational elements played out, various arms of the federal government did nothing to moderate the wild expectations. …… The SEC did not try to make public company accounting more realistic—until after the bubble collapsed. …… As for the Federal Reserve, it positively egged on the perky mood. ….”

Instead of taking away the bowl, the central bank spiked the punch, hoping to prevent pain. But the wild asset parties ended badly anyway.

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