But the central bank has become part of the growth problem—in part because of policy changes after the 2008-09 financial crisis. Today’s Fed is silent on, or even enables, inflationary fiscal policies. After 2008 the central bank began paying interest on trillions of dollars borrowed from banks and money-market funds—it will pay more than $23 billion in September alone. The Fed bought huge tranches of government bonds as if it were a hedge fund, exposing taxpayers to massive losses when rates eventually came back up. The bond buying heavily subsidized Washington and other elite bond issuers but contributed directly to the global wave of inequality and excess government debt. At the same time, the Fed greatly intensified its regulatory control over bank lending, pushing banks away from the short-term working capital lending needed for robust growth.
In essence, the central bank is picking winners and losers. The New York Federal Reserve Bank’s April Open Market Operations report describes a plan to buy trillions more in government bonds, further entwining fiscal and monetary policy, concentrating capital, and channeling it to one of the biggest winners—government.
Present policy envisions high short-term interest rates, permanent central-bank ownership of bonds, and silence on the dollar and fiscal policy. We need the opposite. Rather than setting rates even higher—or, worse, changing the inflation target from 2% to 3%—the Fed should create a path to rate cuts through policies that provide price stability and faster supply growth. This would curb inflation through an economic expansion rather than a contraction.