United States:

The FED will have to navigate between two possible mistakes ...

Now that the Fed is getting closer to its first rate hike, it has become clear that monetary policy has to navigate between two possible mistakes: tightening too quickly or doing too little too late! Two past episodes may bring some perspective to the possible consequences of those two types of policy mistakes.

• In 1936, to prevent an “injurious credit expansion”, the Fed doubled the banks’ reserve requirement ratios. This policy, complemented by the Treasury’s policy of sterilizing gold inflows, led to a sharp contraction of the monetary base and sent the economy back into recession. Tightening cautiously is essential!
• At the beginning of the 1960s, the government had made low unemployment a “national priority” and, in the middle of that decade, the Johnson administration put pressure on the Fed not to tighten. William McChesney Martin, then chairman of the Fed, tried to find a “trade-off”: monetary policy would stay more accommodative if fiscal policy was tighter. However, Congress did not pass tax increases until June 1968: by that time, inflation had already started to move higher and it became clear that the Fed was too late!

Let’s hope that, with the benefit of hindsight, the Fed manages to avoid doing too much too soon … as well as too little too late!

 

The Macro Team