What does successful Fed policy look like?

During 1994, the Fed unexpectedly increased interest rates, and this helped to preserve price stability and high employment for many more years. But according to the FT, 1994 is a cautionary tale:

The current Fed approach to communicating with market participants is its way of dealing with what could be called the 1994 problem. In February of that year, the US central bank caught investors around the world off guard when it raised rates for the first time in five years — by 0.25 percentage points to 3.25 per cent.

US bond prices fell and the S&P 500 index dropped 9 per cent over the next month. Amid the ensuing turmoil, California’s Orange County, which had used public money to make complex bets that interest rates would remain low, filed for bankruptcy.

In the years that have followed, the US central bank has taken pains to avoid surprising the markets, which makes sense. Dislocations of the 1994 kind obviously complicate the Fed’s mission to promote price stability and maximum sustainable employment.

That final sentence makes no sense. If interest rates are volatile but inflation and employment are stable, that counts as a big success, doesn’t it? Why would the Fed prefer stable interest rates to a stable economy? Why would “dislocations” complicate Fed policy? I’m an Orange County resident, and even I couldn’t care less about their bankruptcy.

Perhaps the Fed avoided an unexpected rise in rates late last year due to fear of destabilizing the financial markets. If so, then the Fed’s desire to avoid surprising the markets has produced a very unstable economy, with an increased risk of recession in 2023.

I don’t want to make too big a deal of the Fed’s interest rate policy, which is not the biggest problem at the moment. The main problem is the Fed’s abandonment of FAIT. That’s the primary cause of the current high inflation. The Fed has lost credibility.



44 Responses to “What does successful Fed policy look like?”

  1. Gravatar of Alex S. Alex S.
    11. April 2022 at 22:43

    To make matters worse, the 5×5 breakeven inflation rate is now about 2.5% which translates to a PCEPI of 2.2%. In and of itself that’s not so bad — it was that high as late as 2014. However, it is the first time this has been the case with the 5 year breakeven inflation rate persistently well above that level (3.4% —> 3.1% PCEPI basis). Long story short, the longer run nominal anchor appears to be drifting.


  2. Gravatar of Tacticus Tacticus
    12. April 2022 at 03:03

    What an extraordinarily bizarre complaint. The decline in the S&P was only momentary, too. On a total return basis, it ended the year up!

  3. Gravatar of bill bill
    12. April 2022 at 04:55

    I like Alex’s point. The Fed really needs to establish credibility and get the 5 year breakevens (current 5 year) back in line with their stated policy. I’ve always thought people were too blase by saying “see, the 5yr5yr forward still is anchored”. That coming unanchored is a problem times three. OK, take a few months to get the current 5 years back in line, but if the forwards are out of line, tons of action is needed ASAP.

  4. Gravatar of Michael Rulle Michael Rulle
    12. April 2022 at 04:58

    Many of your readers, myself included, did like when Powell announced his FAIT policy in (2019?). But, as many also asked, myself included, how does one implement such a policy——not mechanically, but as a targeting period. ? I recall your view at one point at least—as an example—-that if by 2030 the Average inflation were not 2% between 2019—2030, then that would be failure—even if it was 2.2.

    Okay—-but what about between 2020-2023? Or between 2021-2022. Or 2022-2025—-or any rolling period one can chose? I became increasingly worried about FAIT, because it really was undefined when looked at that way.

    While I never stated it, I started to believe we should just target a fixed rate——But never did I think we would ever be staring up at 8.5%—-as we are this morning. One thing is super obvious——-the Fed—-and the markets—-really does seem to believe this level is transitory.

    Back to Powell and FAIT. He even pretended he never had a FAIT policy——-which should have caused him to be fired. But replaced by who?

    The market is impressively in non-panic mode—and I have no idea what that means. The 10 year dropped to 2.73% this morning—-up 100bps in 1 year. (Meaning they seem to agree 8% inflation is temporary—right?)

    So what does one think should be done? There are odd things happening in the world. I am beginning to believe China just might be the most superstitious country on earth. Drones and Dog Robots roaming the streets? Is that possible? Is Shanghai really shut down? No information is believable.

    But since China had played the role of the world’s manufacturing hub, if they are shutting down, that seems like a supply problem.

    . Then there is that small issue over in the Ukraine. At some point confusion can lead to bad things ——-Then again, I have a hard time trusting what I read from any media with an agenda (meaning all media).

    What holds true is “the next crisis” always looks different than the last crisis. Short real rates at negative 7-8% ——cannot remember last time that happened. Again, is this more evidence in the “transitory belief”?

    Unemployment is in the 3s—-that does not happen in these situations either. Workers work at home—-does that matter?

  5. Gravatar of Max Max
    12. April 2022 at 05:53

    “So what does one think should be done? There are odd things happening in the world. I am beginning to believe China just might be the most superstitious country on earth. Drones and Dog Robots roaming the streets? Is that possible? Is Shanghai really shut down? No information is believable.”


    It is happening. But did you expect otherwise? The rosy colored China so often portrayed by Scott and others who praise it as the “future” of global governance, or do you expect the CCP’s historically dystopian, orwellian mandates, to violate individual rights, and then use the “common good”, or some other felicific calculus to justify their actions? China is dystopian, not utopian. Its not the future, but a reintroduction of our feudalist past.

    It’s hard to set aside interest rates when speaking of the Fed, because the entire problem is predicated on the Fed’s management of supply, which, invariably, is the result of the federal funds rate. When has the Fed ever been credible? Is it credible to max out your credit cards and ask for more credit? Is it credible to let banks make risk-free loans at tax payer expense? Is it credible to, year after year, steal from the American tax payer through devaluation of the currency? Is it good sense to set interest rates at zero for ten years, with the only benefit being a measly 2.5% growth rate? If we cannot achieve 2.5% without 0% interest, then we need to reevaluate fiscal and regulatory policy!

    In my view, the Fed has never been credible. It’s the conception of a corrupt banking oligarchy, which sought to propagate its necessity to the general public every time America over spent – whether its the reintroduction of the national bank after 1815, or the establishment of the greenback in 1861, the necessity is predicated on raising more wealth then one has access to it, and they do this through the devaluation of the currency you hold.

    At some point the hocus pocus must end. A big correction is most likely on the way.

  6. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    12. April 2022 at 05:55

    re: “Short real rates at negative 7-8% ——cannot remember last time that happened”

    The suppression of interest rates, negative real rates of interest, has a multifaceted transmission mechanism. It stokes asset bubbles and exacerbates income inequality. Ultimately, it is transmogrified into an elevated volume of new money, excessive money flows, culminating in an inexorable stagflationary outcome.

    Lending by the Reserve and commercial banks is inflationary (increases the volume and turnover of new money). Whereas lending by the nonbanks is noninflationary, ceteris paribus (is strictly a velocity relationship where S = I ).

  7. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    12. April 2022 at 06:09

    “The Altimeter for Powell’s Soft Landing”

    “Increases in interest rates may or may not be associated with reductions in the rate of growth in the money supply and nominal spending. The magnitude of the interest-rate effect on the money supply and nominal spending is highly variable.”

    link: Daniel L. Thornton, Vice President and Economic Adviser: Research Division, Federal Reserve Bank of St. Louis, Working Paper Series

    “Monetary Policy: Why Money Matters and Interest Rates Don’t”

    Paul Volcker didn’t stop inflation by raising interest rates, he stopped inflation, the “time bomb”, the release of savings in the 1st qtr. of 1981, by imposing reserve requirements on NOW accounts in the 2nd qtr. But Powell eliminated reserve requirements.

    As I said: The only tool, credit control device, at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be properly controlled is legal reserves. The FED will obviously, sometime in the future, lose control of the money stock.
    May 8, 2020. 10:38 AMLink

  8. Gravatar of David R. Henderson David R. Henderson
    12. April 2022 at 07:34

    Well done, Scott.

  9. Gravatar of ssumner ssumner
    12. April 2022 at 08:05

    Max, I see you are new here. In the slight chance that you are not just a moronic troll, I should probably inform you that I have always detested the CCP, and always will. Perhaps you are confusing me with someone else?

    Please apologize, or in the future I’ll just ignore your comments.

  10. Gravatar of Doug M Doug M
    12. April 2022 at 10:01

    There was a time when it was thought that Fed action was only effective if it was not expected by the market.

    As for Orange County, they would have blown up sooner or later. The treasurer was running his fund like he was a big swinging hedge fund manager with none of the controls. Then he had the gall to suggest that he lacked the mental capacity to understand what he was doing.

  11. Gravatar of Capt. J Parker Capt. J Parker
    12. April 2022 at 10:29

    @ Alex S.
    Why wouldn’t the current levels for 5 Year forward-5 year breakeven rate and the straight 5 year breakeven rate actually be saying that the market buys Powell’s line – Inflation is temporary and will decline?

  12. Gravatar of Alex S. Alex S.
    12. April 2022 at 12:20

    @Capt. J Parker

    Correct me if I’m wrong but your Q is that why wouldn’t TIPS be reflecting what the Fed says is going to happen (i.e. high inflation today at target inflation in the longer run?). If markets felt the Fed had lost its inflation fighting credibility. For example, if the Fed gets too distracted blaming high inflation on things other than itself it would signal that the Fed won’t take the necessary actions to control inflation.

  13. Gravatar of William Peden William Peden
    12. April 2022 at 13:53

    1994 is among the Fed’s best moments. More impressive than the Volcker shock. And more impressive BECAUSE it was so unmemorable.

    I have been astonished by macro ignorance recently, e.g. people suggesting that the squeeze in real incomes will reduce inflation. I suppose their model is High Real Growth -> Inflation…

    Joseph Stiglitz is endorsing price controls and other supply-side measures to deal with this inflation. Paul Krugman is expecting inflation to come down with massively negative real interest rates.

    This is the left’s moment of macro madness, not yet as terrible as the right’s in 2009-2014 but still awful and the cause of unnecessary suffering in the long run.

  14. Gravatar of foosion foosion
    12. April 2022 at 17:37

    @Alex, that’s not a very big drift. TIPS prices could be elevated due to inflation fears. TIPS effectively include an inflation insurance component and it’s easy to see how such insurance could be more expensive these days.

  15. Gravatar of Rodrigo Rodrigo
    13. April 2022 at 04:45


    Is all hope lost? How can the fed engineer a soft landing from here?

  16. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    13. April 2022 at 06:01

    The effect of the FED’s operations on interest rates (now largely via the remuneration rate), is indirect, varies widely over time, and in magnitude. What the net expansion of money will be, as a consequence of a given injection of additional reserves, nobody knows until long after the fact.

    The consequence is a delayed, remote, and approximate control over the lending and money-creating capacity of the payment’s system. The consequence is FOMC schizophrenia: Do I stop because inflation is increasing? Or do I go because R-gDp is falling?.

    Monetary policy should delimit all reserves to balances in their District Reserve bank (IBDDs, like the ECB), and have uniform reserve ratios, for all deposits, in all banks, irrespective of size (something Nobel Laureate Dr. Milton Friedman advocated, December 16, 1959).
    As I said May 23, 2020.

  17. Gravatar of Alex S. Alex S.
    13. April 2022 at 07:01


    Are you speaking specifically of the inflation uncertainty premium in nominal Treasury securities as adding a greater wedge between nominal securities and TIPS?

    I take your point that the upward movement in the 5×5 TIPS spread isn’t that large, however it’s the highest since late 2014, and even more troubling is that it I’m those earlier instances the 0x5 was generally below the 5×5.

  18. Gravatar of OG OG
    13. April 2022 at 07:29

    I think you hit the nail on the head – the Fed has an introduced an element to its reaction function that is financial stability, which implicitly leads to avoiding large drawdowns in asset prices.

    As you say, the whole *point* of monetary policy is to exchange the output, prices and employment volatility under a laissez faire money market with higher interest rate (and perhaps exchange rate) volatility to gain macroeconomic stability. Capital formation is promoted because while someone in the economy has to bear more interest rate risk, future profits and wages are more predictable. The ZLB caused everyone to forget this by largely eliminating perceived interest rate risk from the economy – now we are remembering.

  19. Gravatar of OG OG
    13. April 2022 at 07:31

    I should add perhaps that interest rate risk can be transferred more easily than profit or wage risk because there are fewer incentive alignment problems or information asymmetries etc.
    Perhaps this is why activist monetary policy is efficient.

  20. Gravatar of marcus nunes marcus nunes
    13. April 2022 at 07:40

    Compare the US to Europe. Monetary policy was much more effective in US (in the sense it allowed for a quicker economic recovery). In the presence of supply shocks/constraints, best the Fed can do is to keep NGDP on a stable path. While monetary policy in Europe remained tight, in US it went somewhat “overboard”. That´s why inflation in US higher than Europe. But I suggest a “gentle solution”!

  21. Gravatar of Carter Carter
    13. April 2022 at 08:32

    A successful Fed policy is no Fed policy.
    Please close that building permanently. You can turn it into a homeless shelter for poorly run, corrupt, democratic cities, where 99% of our homeless live. The People who work at the Fed, along with the politicians and economics who support them, should then be forced to read the book “slipper slope”, by william bailward before taking any other position in academy or government – ever.

  22. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    13. April 2022 at 09:51

    Inflation’s Peak Won’t Give Us a Rate Reprieve; Justin Lahart

    “Raising interest rates while inflation is going up is easy for the Federal Reserve to justify. Raising them when inflation is going down might be harder.”

    Powell’s going to wait until the 4th qtr. 2022?

  23. Gravatar of foosion foosion
    14. April 2022 at 04:53

    @Alex – yes. Uncertainty about inflation should increase the spread between nominals and TIPS.

  24. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    14. April 2022 at 06:05

    This isn’t Nassim Taleb’s Black Swan (Russia and Covid). It isn’t as Brainard says in her interview with Nick Timiraos of the Wall Street Journal Wednesday morning, “it is difficult to guess what to do because the models aren’t perfect”

    The models don’t have to be perfect. It takes two full years of miscalculations to incessantly drive up inflation. And it takes two full years of a tight money policy to drive inflation back down.

    It’s not as marcus nunes says: “The dynamic AS/AD model tells us that the best the central bank can do faced with a supply shock is to keep AD (NGDP) growing stably along its trend path. That’s what the OPEC Oil Embargo, 1973–1974 was all about. The FED validated OPEC’s administered price hike. How’d that work out?

  25. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    14. April 2022 at 07:25

    As Steve Keen said: “The real cause of the “stag” half of stagflation was the decline in demand as credit collapsed from 12 percent to 6 percent of GDP between September 1973 and 1976.”

    So, the FED attacks velocity to reduce inflation (acting predominately on R-gDp), raising policy rates (destroying S=I), as opposed to the larger volume of new money (by raising reserve ratios).

  26. Gravatar of ssumner ssumner
    14. April 2022 at 08:17

    Rodrigo, You asked:

    “Is all hope lost? How can the fed engineer a soft landing from here?”

    No, there’s still hope. NGDP growth of 3% to 4% for a couple years would do wonders. But the risks are elevated.

  27. Gravatar of Michael Sandifer Michael Sandifer
    14. April 2022 at 16:03


    Why does NGDP growth need to come down to 4% or lower for a couple of years, instead of the expected growth path simply coming down to 4%, for example?

  28. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    15. April 2022 at 05:45

    An example of a decline in required reserves (a tighter monetary policy):

    Some people think Feb 27, 2007 started across the ocean. “On Feb. 28, Bernanke told the House Budget Committee he could see no single factor that caused the market’s pullback a day earlier”.

    In fact, it was home grown. It was the seventh biggest one-day point drop ever for the Dow. On a percentage basis, the Dow lost about 3.3 percent – its biggest one-day percentage loss since March 2003.

    Greenspan did the same thing causing “Black Monday”. The shortfall in the quantity of legal reserves supplied by the FRB-NY’s trading desk (which had already dropped at a rate not exceeded at any time since the Great Depression) bottomed with the bi-weekly period ending 10/21/87.

    But looking backward one doesn’t see the correlation. I.e., you can’t perform a regression test against the data. Why? Because the FED always covered up its Elephant Tracks.

  29. Gravatar of ssumner ssumner
    15. April 2022 at 07:44

    Michael, A bit below 4% is ideal, as the economy is currently overheated.

  30. Gravatar of mpowell mpowell
    15. April 2022 at 20:17

    I don’t think the fed’s credibility is really gone yet, so a soft landing may still be possible. A 0.5% hike would really help, or an off-schedule 0.25% hit.

    This has been an interesting episode to observe involving the potential difference between the expectations view of monetary policy and the ‘concrete steps’ view. I normally think expectations is most of the game, but with so much fiscal stimulus and a delayed fed response, I think we are entering a zone where ‘concrete steps’ will have to be pretty serious to have the desired effect.

    I’ve been reading this blog for probably 10 years or more and mostly agreeing with Scott’s main points. But I do think in a severe situation the actual pathway of fed policy to market impact becomes much more academically important. As someone with a background in control theory, the conventional wisdom approach of slow, small steps is maddening. Putting a slow integrator into your feedback path is a sure-fire way to create an unstable system. Which means, in this case, you get overshoot and a hard landing. The expectations channel can act like a fast-acting proportional control path but when it’s not enough you need a faster ‘concrete steps’ response.

    I think the main concern the fed has is if they really surprised with a big rate step and there was huge movement in the financial markets, would that itself trigger a recession? But my question would be, is a sudden medium sized rate change really worse than a slow change that ends up being significantly bigger? That’s why I think the pathway question is actually important in this kind of scenario.

  31. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    16. April 2022 at 07:23

    “If the Fed wants a soft landing, its focus must be on the rate of growth in the money supply, broadly measured.” — John Greenwood and Steve H. Hanke WSJ – April 10, 2022

    “What is the adequate rate of growth for the money supply that would eventually hit the Fed’s inflation target of 2%? It’s the “golden growth” rate of around 6%. By taking the growth rate in M2 down from its current level of 11%, Mr. Powell can bring inflation down and land softly.”

    You wonder about their credentials. M2 is mud pie. The volume of money (stock) is irrelevant unless it is turning over (flow).

    The fiscal helicopter drops repeatedly injected unpredictable economic disturbances into the conventional rate-of-change in money flows. But that doesn’t mean you abandon a 100 + year historical trend.

    The rate-of-change in short-term money flows, the proxy for real output, bottoms after the 1st qtr. of 2022 (Atlanta’s gDpNow is reading 1.1% for the 1st qtr.). The FED would have to further restrict any additional money growth so as to cause a recession.

    The upshot is that the FED will have to stay the course for 2 full years, continuing a prolonged tightening of monetary policy in order to bring inflation down.

  32. Gravatar of ssumner ssumner
    16. April 2022 at 09:16

    mpowell, I keep coming back to the policy target. They never should have abandoned FAIT. When the market has no idea where things are going, mistakes are far more likely to occur.

  33. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    16. April 2022 at 09:32

    John Cochrane has an excellent article on inflation; “Inflation and the end of illusions”

    “The “secular stagnation” debate is settled”…”We now know that it was supply”…”One still hears that inflation comes from vulnerable supply chains, nefarious price gouging, profiteering, monopoly, and greed.”

    “Since 2000, long-term growth has fallen by half”. A lack of commitment by the FED, N-gDp targeting, is partly responsible.

    But the real culprit comes from the likes of the Keynesian economists that maintain a commercial bank is a financial intermediary. It is George Selgin’s error: “Yes, I hold that commercial banks are credit intermediaries and not just credit creators”

    From the forest, not the trees, banks pay for their earning assets with new money. So, from a macro-accounting perspective, all bank-held savings are un-used and un-spent, lost to both consumption and investment. Ergo, non-inflationary supply is reduced. I.e., as an increasing volume and percentage of bank deposits are saved, velocity drops.

  34. Gravatar of Tacticus Tacticus
    16. April 2022 at 09:38

    I had lunch with some important (from an AUM perspective) Britain-based buyers of Treasury bonds today. Always interesting times with these chaps (no women amongst them, for reasons I don’t quite understand. I know women in ESG, equities, volatility, rates, PE, corporate bonds, basically everything except government bonds. Why is that? I digress. It was a boozy lunch.)

    They hadn’t per se focused on the abandonment of FAIT. They were more in general concerned that Fed officials seem to be giving an unprecedented amount of statements to the Press, without actually doing anything. ‘All talk, no action.’ I specifically asked about FAIT, they basically said they never really believed it but definitely didn’t now. It was just another unbacked statement intended for the short-term reaction.

    Caveat emptor: of course, everyone is always just talking their book; but I thought it was an interesting tell. The Fed COULD have made FAIT a thing, but chose not to, adding to a general lack of credibility, from the City’s perspective.

  35. Gravatar of Jeff Jeff
    16. April 2022 at 11:50

    Tacticus, that seems correct. Watch what they do, not what they say. Do they really think people are so stupid as to believe they have to wait till the next meeting to raise rates, with all the emergency bailouts they’ve engineered? It seems their entire goal is to rip you off slowly, so they don’t look as bad.

  36. Gravatar of Kester Pembroke Kester Pembroke
    17. April 2022 at 06:59

    The cost of borrowing money isn’t even on the table in any business discussion because it is a rounding error compared to the sales projection risks and even the valuation of the collateral. It’s not even in the same order of magnitude as the standard error of the actual risks of doing business.

    That’s before you get into a discussion about term lengths for loans (which easily neutralises interest rate changes on the monthly cost) or the fact that interest is paid to bankers, bankers are human and they spend as well which would validate the markup on costs that includes the interest charge.

    The whole idea of interest rates is based upon pavlovian beliefs about people that have no basis in reality.

  37. Gravatar of Bobloblaw Bobloblaw
    17. April 2022 at 11:56

    The only time the Fed engineered a soft landing was when it raised rates ahead of rising inflation, not when it let inflation get out of hand before raising rates.

  38. Gravatar of ssumner ssumner
    17. April 2022 at 21:15

    Tacticus, Yes, it’s so unfortunate the Fed blew it.

  39. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    18. April 2022 at 06:19

    re: “The only time the Fed engineered a soft landing”

    “Let’s look at Mr. Powell’s examples. The Fed tightened monetary policy by increasing the federal-funds rate significantly in 1965 (from 3.4% to 5.8%),”

    While the FED was tightening monetary policy (reduced legal reserves by 1b from April to October 1966), “On July 20, 1966 the Reserve Authorities made the first reduction of interest rate ceilings on time deposits since February 1, 1935”

    “Whereas time deposits were 105 percent of demand deposits in July, by the end of the year, the proportion had fallen to 98 percent.”

    I.e., the FED tightened money while increasing velocity.

  40. Gravatar of Spencer Bradley Hall Spencer Bradley Hall
    18. April 2022 at 07:01

    re: “NGDP growth of 3% to 4% for a couple years would do wonders”

    That’s too low. Look at R-gDp
    2018-07-01 1.9
    2018-10-01 0.9
    2019-01-01 2.4
    2019-04-01 3.2
    2019-07-01 2.8
    2019-10-01 1.9
    2020-01-01 -5.1

    The number of trucking company bankruptcies in 2019 was a set up for the Covid supply-chain issues.

  41. Gravatar of postkey postkey
    19. April 2022 at 02:53

    “Economic freefall
    Just how bad is Britain’s current economic collapse?
    One indicator can be found in the monthly registration of new vehicles, which are generally higher in September and March when new registration plates are introduced. Nevertheless, total registrations were down 14.3 percent on this time last year – when the UK was still subject to lockdown. . . . the bigger concern is in the 27.6 percent fall in light commercial vehicle (LCV) registrations.” ?

  42. Gravatar of Effem Effem
    19. April 2022 at 05:58

    Now 5y5y inflation expectations are moving upwards rapidly. This is a central bank losing control and pretending not to notice.

  43. Gravatar of vince vince
    19. April 2022 at 14:46

    What does a successful fed policy look like? Maybe Scott has some answers in his contribution to Cato’s new book, Populism and the Future of the Fed. Tell us about it, Scott.

  44. Gravatar of ssumner ssumner
    20. April 2022 at 08:33

    “What does a successful fed policy look like?”

    Stable NGDP growth at around 4%

Leave a Reply