News

Belief in Fed’s Ability to Manipulate Economy Remains Strong

Let's start with what Robert Prechter wrote in the first edition of Conquer the Crash (2002):

The primary basis for today's belief in perpetual prosperity and inflation with perhaps an occasional recession is what I call the "potent directors" fallacy. It is nearly impossible to find a treatise on macroeconomics today that does not assert or assume that the Federal Reserve Board has learned to control the credit supply, interest rates, the rate of inflation and the economy.

That belief in the Fed's ability to manipulate the economy remains true in 2020, as reflected by a major news organization's headline (Reuter's, Feb. 21):

In next downturn, Fed may opt for quick, strong action

Here's an excerpt from the article:

In the next economic downturn, the Federal Reserve and other central banks may need to roll out their big guns sooner and use them more aggressively, or risk getting mired in growth-sapping deflation or worse.

That was the argument laid out Friday by a group of veteran monetary policy analysts and Federal Reserve Governor Lael Brainard, who called for using now-familiar policy tools like forward guidance more forcefully, and adopt new ones like capping interest rates to bolster the Fed's clout.

The broad approach appeared to have some support among other policymakers grappling with the how the Fed and other central banks should prepare to fight a future recession. If there is disagreement, it is not over the general idea that tools like massive bondbuying - or "quantitative easing" - are now a staple of central bank practice; it is over how specifically the Fed should spell out its future crisis-fighting plans in advance.

Intense efforts are underway at central banks globally to develop new ways to fight shocks amid low inflation and low interest rates that make conventional responses, like simply reducing a target borrowing rate, less potent than previously...

Brainard's call for expanding the Fed's policy arsenal to battle coming shocks came in response to a paper showing that the central bank's bond-buying and forward guidance deployed during the last crisis had only mixed results and that argued those tools could have been more effective had they been used more decisively.

However, the widely held belief that central banks can prevent deflation is just as Conquer the Crash described -- a fallacy.

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