Federal Reserve Faces a Policy Dilemma of Its Own Design

The Federal Reserve is in a deep hole of its own making as its top policy committee meets this week to announce the start of a long-anticipated cycle to raise interest rates. Inflation is at a 40-year high and still accelerating, the Fed’s inflation-fighting credibility is damaged, and it has lost control of the monetary policy narrative.

Add to that the new host of uncertainties facing the global economy because of Russia’s invasion of Ukraine and it should come as no surprise that members of the Federal Open Market Committee have expressed divergent views in the run-up to their deliberations. Keeping the FOMC united is a tricky challenge for Chair Jerome Powell. Yet it pales in comparison to the importance of making the right decision among less-than-ideal policy options.

The Fed’s multiple headaches, as significant as they already are, do not stop there. I suspect that it will also face renewed criticism no matter what it decides this week. Understanding why is critical to illustrating the considerable uncertainty facing policy and the global economy, compounded by the tragedy in Ukraine.

A menu of choices that are less than optimal is often associated with policy making, like the current Fed’s, that has fallen seriously behind developments on the ground, especially if citizens feel the pain directly, as many do today with soaring prices. The central bank’s policy dilemma is particularly acute. Finding itself far away from the world of first best policy responses — for that, the Fed should, and could, have started easing its foot off the stimulus accelerator last summer, as some of us advocated — the options that the central bank has are far from straightforward and satisfactory.

Just consider the two main policy alternatives for the Fed.

With the “maximum employment” mandate met, according to Fed officials themselves — albeit with the level of labor force participation still too low — the central bank could go all in on inflation.