How the Federal Reserve messed up the economy

 Wall Street Journal:

History will give a full accounting of the grave errors committed in recent years in economic policy. A central lesson is already clear: Nothing is as expensive as free money.

The costs of the Federal Reserve’s zero-interest policy are multiplying: The misallocation of capital—goosing the price of the riskiest and least-productive of assets—set the conditions for boom and bust. The financing of the “big state” set the country on an unsustainable fiscal trajectory. The extraordinarily loose financial conditions created herd behavior among market participants and firms and complacency among policy makers, including regulators. The surge in inflation substantially raised the cost of living for citizens and undermined business planning.

The latest consequence, arising from a reversal of the monetary madness, brings to the surface the fragility that has long lurked in the financial system. I expect credit to contract and the economy to weaken.

The Federal Reserve’s zero-rate policy ranks among the most significant economic policy errors in nearly half a century. After more than a decade of negative real interest rates, the Fed doubled down. 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.

Inflation is a choice, and the Fed chose higher inflation. That’s exactly what we got. Inflation ripped higher starting in 2021 amid an economic boom. For most of 2022, inflation in the U.S. ran about 7% to 8% on an annualized basis, nearly quadruple any plausible measure of stable prices.

Belatedly and begrudgingly, at its March 2022 Federal Open Market Committee meeting, the Fed began to acknowledge its error. It raised rates, but only from zero to 0.25%, on the theory that it’s best not to frighten the horses.

The horses were already out of the barn. Inflation was never “transitory,” and it couldn’t credibly be explained away by war and pestilence. In the subsequent six meetings of the FOMC last year, the Fed raised interest rates 4 percentage points and shrank its balance sheet by about $600 billion. That’s an impressive clip. If the lyrics matched the music—and the Fed’s communications were as resolute as the actual rate rises—the central bank would have gotten more disinflationary bang for the buck.
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Its inflation policy screwed up the bond market which led to harming the liquidity of the banks which resulted in bank bailouts. Some banks made matters worse with poor investment decisions.  Biden made matters worse with his reckless spending policies  which accelerated inflation.