PEORIA MAGAZINE December 2022

easing, whereby it had been bloating its balance sheet with the purchase of long-term government bonds in an exercise to directly hold down long term interest rates. This turnaround was expected to bring an end to the long-lived policy of “easy money” required by the slow recovery from the financial crisis. While the Fed was in the early stages of this tightening, COVID struck and the fiscal policy response to the rapid but short-lived economic plunge was to run up a huge federal deficit to pumpmoney into the pockets of businesses, state and local governments, and individuals and households. The Fed immediately reversed course to an accommodative monetary policy stance. It is clear that both the fiscal and monetary policy adjustment paths were correct in facing the extremely high level of economic uncertainty. This demand stimulation tided over employees, small and medium sized businesses, and state and local governments and provided a significant boost to thebalance sheet of households as they built up precautionary savings that they have yet to run down. COVID’s impact on global supply chains did produce some inflationary pressures, which have lingered and portend current and future risks resulting from China’s lockdown policy toward COVID. More recently, the supply side shocks in the energy and grain markets from the Russian invasion of the Ukraine have produced a second round of inflationary impacts, which are working through the system. The Fed’s steadfast commitment to progressing with further rounds of interest-rate increases to dampen aggregate demand appears to be necessary to ensure that inf lation does not become entrenched at an unacceptable level. It is also important to bring interest rates to a sustainable level … so that the Fed can practice effective stimulative policy when needed in the future. The decade of negative real interest rates resulted in inefficient and wasteful investment incentives both for the private and public sectors.

PM: It is not uncommon to find com parisons being made in various media between today’s inflationary episode and that of 40 years ago, or between Jerome Powell and Paul Volcker, with a recent piece in the New York Times declaring that “2022 is not 1982.” Would you agree or disagree? What lessons might be gleaned from 1982, if any? DC: I took out my first mortgage in 1981 and signed up for a 30-year fixed rate loan set at 15% per year. Inflation was running near 12% per annum but the salary raise I received at the end of the year was 20%. Yes, inflation was out of control and distortionary, but people learned methods with which to cope, some better than others. Paul Volcker cut through the politics whereby the executive branch, primarily the Office of the President and the Treasury Department, had for at least a couple of decades unduly influenced Fed policy.* This finally established the Fed as an independent entity with a dual mandate to control inflation without disproportionately impacting the labor market. After Volcker whipped inflation, I refinanced my house with a variable rate mortgage. We should not forget that the real solution to promoting a sustainable rate of economic growth in a non inflationary environment is to invest more in human and physical capital, which will raise economic productivity. That allows growth without upward price pressure. We need a more educatedworkforce, more research and development, and higher investment levels in private and public capital. Hopefully we will also seek to revive an upward, rather than downward, trend in labor force participation … *There are two recent, well-written books looking at the practice of monetary policy in a historical context. They are 21st Century Monetary Policy: The Federal Reserve from the Great Inflation to COVID-19 by former Fed Chairman Ben S. Bernanke, and A Monetary and Fiscal History of the United States, 1961-2021 by former Fed Vice Chairman Alan S. Blinder

Best to leave the job of fighting inflation to those with the experience and tools to wage the battle most efficiently and effectively. That would be the Federal Reserve, which has the mandate to control inf lation while attempting to minimize any necessary tradeoff with employment. PM: Once the Federal Reserve began to take inflation seriously, it moved very quickly and aggressively to confront it, withmixed success so far. Fed Chairman Jerome Powell has said that “we will keep at it until we are confident the job is done.” Does the Fed risk overdoing it? Conversely, what’s the danger of backing off too early? Please discuss the potential ramifications of both, including what historical precedent exists. DC: Overdoing it clearly refers to the costs of controlling inflation, primarily measured by slowed economic growth and its related labor market impacts. The risks are directly related to the sources of the price increases. Prior to the COVID crisis, the Fed was starting a tightening by raising interest rates from the near-zero level and ending its practice of quantitative

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