Has the Fed Learned Any Lessons?

The central bank wants to declare victory over inflation but hasn’t explained its monetary mistakes

WSJ editorial. 

"The Federal Open Market Committee meets this week, and investors are speculating whether Federal Reserve Chairman Jerome Powell will cut interest rates by 25 or 50 basis points. We have a different question: Has the Fed learned anything from its inflationary debacle?

As the central bank pivots from its tightening cycle, Fed triumphalism is in the air. Inflation is said to be vanquished, the fabled soft landing has arrived, and Mr. Powell and his mates are hailed as financial heroes. The Fed can now get back to the business that Wall Street and the financial press want, which is cutting rates (50 points please!) and getting the financial party restarted.

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Sorry to be a spoilsport, but humility is more appropriate than hagiography. The Fed has made considerable progress in reducing inflation from its 9.1% peak in June 2022, and for that it deserves credit. But no one should forget the monetary mistakes that led to the worst inflation in 40 years. 

The Fed calculated that it could monetize an unprecedented peacetime government spending blowout without triggering inflation. When inflation did begin to accelerate, the central bank said not to worry. It was “transitory,” the result of supply-chain obstacles caused by the pandemic. So the Fed stayed too easy for too long—the same mistake it made in the mid-2000s that fed the housing boom that turned to bust and the financial panic.

No one should forget either the cost this inflation burst has imposed on average Americans in a lower standard of living. The price of nearly everything is higher—about 20% higher overall since January 2021—while real wages haven’t kept up. Prices are rising less rapidly now, but they aren’t going back down. Housing is also much less affordable in part because interest rates had to rise to reduce inflation.

This has meant real hardship for tens of millions of wage earnings without nest eggs in financial or real-estate assets. The Fed’s grand monetary experiment since 2008—near-zero interest rates, bond-buying to keep long rates low—have been wonderful for Wall Street and the wealthy. They haven’t been nearly as great for the middle class that survives on salaries and meager savings.

The Fed nonetheless feels it’s time to ease money again, and at this point it has little choice. Failing to cut rates this week would hurt the Fed’s credibility after so much signaling. But some humility would help here too, as the Fed navigates a return to its 2% target that it still hasn’t reached.

While the labor market has softened, overall financial conditions aren’t all that restrictive. There’s plenty of liquidity around, equity prices have boosted the wealth effect on consumer spending, and the prices of gold and other commodities are up. The Chicago Fed’s financial conditions index has been signaling easier conditions of late as well.

Mr. Powell has also been signaling, and may announce soon, a further slowing in the pace of quantitative tightening (QT). Thus it appears the central bank’s balance sheet will remain permanently larger than it was before 2020. This is supposed to allow the Fed to meet commercial banks’ increased demand for reserves. But the looming end of QT is also another signal that easier money is coming. Does this mean that the era of vast bond-buying is here to stay, to be triggered again at the first sign of an economic slowdown?

We don’t agree with those who say a cut in rates this week is political or intended to help Kamala Harris. The real risk for the Fed is if it embarks on a monetary easing cycle that stops the current disinflation and causes prices to rise again. This would do far more harm to the Fed’s credibility than disappointing financial markets with a slower pace of rate-cutting than Wall Street aches to see.

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The larger point is that Fed officials haven’t shown much evidence of introspection over what caused inflation—or for that matter why it has come down without triggering a recession. Mr. Powell took a cautious stab at it in his recent Jackson Hole speech. But his analysis leans heavily on the supply-chain disruptions of the pandemic and excessive spending that boosted demand.

There wasn’t much if any reflection on the Fed’s role, or why its internal models were so wrong on the direction of the economy and prices. In the end he seems to blame “the pandemic economy” that “has proved to be unlike any other.” Perhaps so, but that isn’t reassuring about the future of monetary policy.

Whatever Mr. Powell does, better to keep the corks in the champagne bottles until we know the Fed’s moves have worked—or, better yet, why and how."