Federal Reserve Chairman Jerome Powell on a television screen on the floor of the New York Stock Exchange during his news conference following the announcement of the Fed’s decision to hike interest rates. Picture: EPA
The Fed has made mistakes in the past. Now it seems as if she is managing crises that she caused herself.
It’s hard to resist the realization that the Federal Reserve increasingly has to manage the crises it has triggered. The central bankers don’t even cut a bad figure in crisis management. Fed Chair Jerome Powell appears honest, pragmatic, hands-on and at the same time ready to admit mistakes.
And mistakes have truly been made. Far too late, the Federal Reserve realized that after massive pandemic relief programs, inflation could gallop away. Despite draconian interest rate hikes for more than a year, inflation has so far not been slowed down.
However, the sins began before the 2008 financial crisis, when low interest rates helped inflate assets to the point where the crash happened. Seven years later they lay policy rates at zero, only to climb briefly to 2.5 percent, which is still historically low. After that, they fell back to zero percent to help the economy in the pandemic.
With this long lax policy, the Fed has accustomed economic players to the fact that financing actually costs nothing. Financial institutions have become accustomed to neglecting interest rate risks, the risk of which is usually drilled into bankers in their early years, provided they receive a solid education.
Powell’s warning to politicians
The extraordinarily expansive government spending under donald trump and Joe Biden can also only be explained by the policy-driven view that credit is not a problem when interest rates are close to zero. Now the two political parties, which are in no way inferior in incurring debt, are arguing over how the statutory debt ceiling should be raised. If the politicians cannot agree, then the Ministry of Finance would have to stop making payments. A severe global financial crisis would then be possible.
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Fed chief Powell warned politicians not to delude themselves that the Federal Reserve can protect the American economy in this scenario. That would actually be too much for crisis management. It would have been better if the Fed had made better policies earlier.