The U.S. Needs Economic Regime Change

The cost of stopping inflation would have been lower if the Fed had faced the problem earlier.

By Kevin Warsh. Excerpts:

"In August 2020 at its Jackson Hole, Wyo., conference, the Fed announced a new policy framework to address what it saw as its biggest problem: Inflation was too low at 1.7%. Zero rates and massive Fed purchases of Treasurys and mortgages would be the cornerstone of the new regime."

"For most of 2022, inflation in the U.S. ran about 7% to 8% on an annualized basis"

"Inflation was never “transitory,” and it couldn’t credibly be explained away by war and pestilence."

"At its policy meeting just six weeks ago, the Fed said the economy was softening and the inflation trend was encouraging. The Fed stepped down its rate increase to a quarter point, signaling that rates were asymptotically approaching the peak policy rate in the cycle. The job was getting done—or so it said."

"Then, two weeks ago, in testimony to the Senate Banking Committee, Fed Chairman Jerome Powell reversed again. He said that the economy was decidedly stronger and inflation higher than expected."

"The Fed would have been wise to raise rates from zero earlier in the economic cycle. The economy and financial system were decidedly stronger. The country was much better positioned to handle rate increases in 2021 than today. The terminal interest rate—the peak interest rate in the cycle—needed to break the back of inflation was lower. The longer the central bank waited, and the more uncertain its trumpet, the more monetary might had to be deployed to quash the inflation monster"

"To get inflation to fall meaningfully, economic theory and practice suggest that the Fed’s policy rate should exceed the inflation rate on a sustained basis."