It is often said that those who cannot learn from history are doomed to repeat it. Jerome Powell’s Federal Reserve Board would do well to heed that adage. By seeming to have learned little from both the 2008 housing and credit market bust and our painful inflationary experience in the 1970s, it risks repeating those two sorry economic episodes.
In 2009, in the aftermath of the bursting of the housing price bubble, Federal Reserve Chairman Alan Greenspan quickly went from hero to zero. He did so as the bubble’s burst ushered in the Great Recession. Hauled before a congressional committee, Greenspan was forced to publicly confess that he should have paid more attention to the housing price bubble that formed under his watch and relied less than he did on the ability of markets to correct their excesses.
Fast forward to 2021, Powell, today’s Fed chairman, seems to be paying little attention to the global “everything” asset price and credit market bubble that has formed as a result of the Fed's massive bond-buying program in response to the COVID-19 pandemic. Instead, it continues to add froth to the “everything” bubble by buying $120 billion a month in U.S. Treasury bonds and in mortgage-backed securities.
Never mind that U.S. equity prices have now reached lofty levels experienced only once before in the last 100 years or that U.S. housing prices are now increasing at an 18 percent annual rate and exceed their 2006 peak. Never mind too that interest rate spreads on the riskiest loans, including those in the emerging markets, have dropped to close to their all-time lows, while the prices of exotic assets have reached the stratosphere.
By turning a blind eye to the bubbles that it has created, the Fed is now running the real risk of a hard economic landing next year when the current music of ultra-easy money eventually stops. This is particularly so considering that the “everything” bubble has been premised on the assumption that today’s ultra-low interest rates will last forever.
In the 1970s, the U.S. experienced its worst inflation in the post-war period. It did so as the Fed kept monetary policy excessively loose and allowed the money supply to balloon in its effort to return the economy to full employment in the wake of two international oil price shocks. Soaring inflation battered the U.S. economy, and it only ended when Paul Volcker’s Fed slammed the monetary policy brakes on hard through a large interest rate hike.
Fast forward to 2021, and now we have a Fed continuing to maintain ultra-low interest rates and allow the money supply to balloon in its effort to return the economy to full employment following the COVID economic and health shock. It is doing so even as global supply chain disruptions are making a return to full employment improbable even with the easiest of monetary and fiscal policies. It is also doing so even as inflation and inflation expectations increase to their highest levels in more than a decade and as job openings skyrocket to record levels now exceeding the total number of unemployed.
As it did in the 1970s, the Fed keeps dismissing the supply-side problems plaguing the U.S. economy as but a transitory phenomenon. It does so even as inflation took it by surprise and as evidence keeps mounting that the global supply chain will take longer than previously anticipated to mend. Worse yet, the Fed discounts out of hand any notion that the economy could soon overheat as a result of its extraordinarily easy money policy being combined with the country’s largest peace-time budget stimulus on record.
By now it is too late for the Fed to prevent a dangerous asset price and credit market bubble from forming or to spare us from an unpleasant inflationary episode. But what the Fed can and should do is dial back its excessively easy monetary policy stance with a view to preventing these problems from getting more serious. Judging by the Fed’s past performance, I’m not holding my breath waiting for that to happen.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.