Studying the history of central banking monetary policy is similar to the study of Monetary policy blunders.
So, let us take you on a time machine adventure, travelling back in time to the 1930s, a sweet and sour period known as the “golden age,” the evolution of many cultural trends, and also the Great Depression.
“Studying the history of central banking monetary policy is similar to the study of Monetary policy blunders”
Jazz and swing, the music of the era, filled the sound waves, and the Federal Reserve created in 1913 was just a few decades old and was about to make its first of many monetary policies plunders
In the 1930’s the Fed’s critical mistake, its first in a string of monetary policy plunders spanning eight decades, was its failure to recognize its lender-of-last-resort responsibilities.
What then played out was deflation on an unprecedented scale, the collapse of the US price level, whcih fell by 21 percent percent between 1929 and 1932.
Moreover, since the demand for commodities, including food and oil, was inelastic, their price fell even faster.
So, collapsing commodity prices and massive deflation was due to the central bank’s relatively inactive monetary easing policy, which was a feature of the 1930s. Deflationary pressure was even worse for commodities, which caused distress among primary producers.
“collapsing commodity prices and massive deflation was due to the central bank’s relatively inactive monetary easing policy”
So, it is clear that the Fed is taking a note from history and its previous Monetary policy blunders.
In the 2020’s, the Fed is implementing an unprecedented monetary easing policy and, we see commodity prices rising not due to demand but rather currency debasement, which could be a deliberate policy intended to keep commodity prices buoyant.
“the Fed implemented what economists would call a “stop-go” monetary policy strategy which entailed fighting high unemployment and high inflation” – Win Investing
Another one of the monetary policy plunders came during the swinging 60s and the “Me” decade of the 70s when Fed policymakers thought that they could lower unemployment through higher inflation, a tradeoff known as the Phillips curve
So, in the 1970s, the Fed implemented what economists would call a “stop-go” monetary policy strategy which entailed fighting high unemployment and high inflation.
During the “go” periods, the Fed would implement monetary stimulus policies by lowered interest rates to loosen the money supply, thereby targeting lower unemployment. During the “stop” periods, when inflationary pressures built up, the Fed would raise interest rates to reduce inflationary pressure.
But “stop-go” monetary policy strategy ended up being one of the monetary policy plunders over the period
Phillips curve trade-off didn’t succeed probably due to monetary policy time lag. “Stop-go” monetary policy was too unstable in the long run, which became apparent as inflation and unemployment increased together in the mid-1970s. While unemployment trended down slightly by the end of the decade, inflation continued to rise, reaching 11 percent in June 1979.
Monetary policy time lag makes implementing policy tricky, and that could be why there have been so many monetary policy plunders over the decades
Think about it. Policymakers are trying to predict, guess, where the economy will be six months from today and then implement a policy, which will likely have an impact on the economy in six months’ time.
“Excessive monetary tightening by the Fed is what burst the internet bubble causing the dot-com crash and the 90s recession” – Win Investing
The 80s was a decade of yet another one of those monetary policy blunders spanning the decade
The in March 1980 the Carter administration precipitated a sharp recession. As unemployment started to spike, the Fed eased up. The Fed implemented a policy similar to the “stop-go” monetary policies that market watchers had come to expect. In late 1980 and early 1981, the Fed flipped to a stop policy, thereby once again tightened the money supply, allowing the federal funds rate to approach 20 percent. Despite this, long-run interest rates continued to rise. Moreover, the ten-year Treasury bond rate increased from about 11 percent in October 1980 to more than 15 percent a year later. Maybe the market thought that the Fed would back down from its tight policy when unemployment rose (Goodfriend and King 2005). This time, however, Volcker was adamant that the Fed not back down: “We have set our course to restrain growth in money and credit. We mean to stick with it” (Volcker 1981a).
Excessive monetary tightening by the Fed is what burst the internet bubble causing the dot-com crash and the 90s recession
Most recently the 2013 “Taper Tantrum” is another example of Monetary policy blunder
Back then the Fed was contemplating a move to monetary normalization which entailed several rate hikes and a winding up of QE. But when the market got wind of the Fed’s monetary tightening, emerging market stocks tumbled together with bonds and emerging market currencies. So, the Fed’s attempted tightening in 2013 triggered a G7 stock sell-off and an emerging market crisis which resulted in an Argentina default on bond payments.
In light of the monetary policy blunders, we believe the next market sell-off is more likely to be triggered by Fed’s tightening in what could be a “stop-go” monetary policy strategy implemented in the 60s and 70s.
Moreover, a history of monetary policy blunders suggest that the Fed is likely to do too much, or too little to balance the risk of spiraling unemployment and inflation
But until then it is party time with so much fiscal and monetary policy easing providing ample liquidity there is only one way for markets to go in the medium short term. Moreover, the Fed and its western aligned central banks continue to demonstrate that they are committed to preventing a market meltdown. In other words, the Fed is underwriting the bull market.
Meantime, signs of trouble could come from the rising treasury ten-year yields and a rising dollar index. Put another way, if capital flows are not flooding into stocks, bonds and instead of sitting it out on the sideline in deposit accounts in USD then you have got to ask yourself why?