US Secretary of the Treasury and former Fed Chair Janet Yellen once told me that the Fed’s rate-setting Federal Open Market Committee will tend to overreact to the immediate news cycle unless it bases its thinking on some transparent formula like the Taylor Rule. But while the Taylor Rule made sense during the Great Moderation, the days of persistently low and stable inflation are gone, and the Fed has no replacement framework to elevate its thinking above the news-driven groupthink.
Not without reason, financial markets seem to be betting that the Fed is about to make mistake number two: pursuing policies that will likely drag the US back toward secular stagnation. If past is prologue, we eventually will return to a scenario in which monetary policy is stuck at the zero lower bound. The economy may suffer another lost half-decade of growth, and socially and politically destabilizing inequalities will become even more pronounced.
J. Bradford DeLong is professor of economics at the University of California, Berkeley and a research associate at the National Bureau of Economic Research. He was deputy assistant U.S. Treasury secretary during the Clinton administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.