Washington Post’s Samuelson: Fed’s Previous Target Setting Had ‘Disastrous’ Results

Monday, 17 Dec 2012 11:43 AM

By Michael Kling

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The Federal Reserve’s decision to link its easy monetary policy to specific unemployment and inflation targets got plenty of attention last week. What went unnoticed was that the Fed has tried it before and failed — with “disastrous” results, writes Washington Post opinion writer Robert J. Samuelson.

The Fed said it will keep interest rates low until unemployment falls to 6.5 percent or inflation reaches 2.5 percent.

The Fed also used targets in the 1970s, although they were implicit and not announced. Its goal back then was an employment rate of 4 percent and inflation between 3 to 4 percent.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

"The result was economic schizophrenia," Samuelson writes.

Easy credit prompted inflation, which caused tighter credit that, in turn, increased unemployment, he states, noting that inflation was 13 percent and unemployment was 7 percent by 1980.

The Fed may know more now, but it still cannot hit specific unemployment and inflation targets simultaneously, he warns. "Striving to do so risks dangerous side effects, including a future financial crisis."

The Fed has limited power to control the economy. Its aggressive efforts to drive down interest rates to boost lending and spur job hiring have produced only modest gains, Samuelson writes.

In addition, inflation remains a threat. The Fed predicts low inflation next year due to high unemployment and surpluses in most industries, but they've been wrong before, he says. Companies’ pricing power could quickly increase if the recovery accelerates.

The Fed, Samuelson asserts, has shown that it has limited ability to predict the economy's course. It failed to anticipate the 2008 financial crisis and has consistently overestimated the strength of the recovery.

The Fed's policy is creating a financial crisis, specifically a bursting bond market bubble. Bondholders could suffer huge losses and panic could spread.

It's questionable if the long-term risks of the Fed's strategy are worth the potential short-term benefits, Samuelson writes, saying the decision is a “close call.”

Warnings of rising inflation abound with every round of central bank easing, but those fears have largely been proven to be misplaced, according to the Financial Times.

Yet the Fed's announcement indicates that it is willing to accept slightly higher inflation to speed the recovery, the Financial Times says. Lifting its inflation tolerance to 2.5 percent from its previously ironclad 2 percent figure represents a breakthrough decision.

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

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