Inflation Overkill: Moving the Fed into a Global Age

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In its zeal to fight inflation, the Federal Reserve has raised interest rates several times this year. America’s central bankers have focused on the usual set of statistics, growth rate, unemployment, industrial capacity. So have most market watchers. Growth is microanalyzed, almost feared. The domestic economic indicators, as they are called, have mesmerized both central banker and bond trader for so long that neither seems to have noticed just how faded the old red flags have become. They have overlooked a far larger and more important trend, a global economy that has fundamentally changed the inflation calculus.

Inflation is not a threat in the United States. Nor is it for the foreseeable future. It has been remarkably flat and will remain so, unless the Fed or the markets begin spurring inflation with higher interest rates. The Fed and most market watchers have undervalued their greatest allies, open, global, and increasingly fluid markets for goods, labor, and services. International competition will tame prices in a broad swath of the U.S. economy. The old domestic indicators, while perhaps important in gauging certain narrow trends, no longer determine the broader inflation outlook.

America’s central bankers, as well as their counterparts abroad, are running economic policy in a global era from a playbook written for a relatively closed national economy. They are fighting the inflation wars of times gone by, and the markets keep cheering them on. Vigilance against inflation is a legitimate aim, but the Fed also has a broader purpose. Its parallel goal must be to ensure the health of all money and capital markets in their depth, breadth, and liquidity. Today, that task requires a touch far subtler than the broad swipe of interest rate hikes.

The Fed must reassess the supremacy given to both its inflation fight and the use of interest rates as its primary policy tool. The risks that central bankers must balance have shifted. Inflation is far less threatening than the prospect of recession or slow growth, and raising interest rates to dampen inflation offers a cure that is often far worse than the disease. Successful reform will allow the Fed to get off the back of the U.S. economy and give America the more robust levels of growth that it deserves.

IT’S A SMALL WORLD AFTER ALL