Lesson Learned: Central Bankers Can’t Manage Economies All by Themselves

The past three years have shown us the downsides of depending too much on low interest rates, and how a better balance of fiscal and monetary policy can achieve a stronger economy.

In the 2010s, the main economic policy debate was about how to boost the labor market and return inflation to the Federal Reserve's 2% target while avoiding deflation. The Fed settled on a strategy of holding interest rates at 0%, reducing borrowing costs and boosting financial asset valuations throughout the economy. The hope was that this combination would lead to more hiring and investing by companies.

While it was the best option the Fed had at a time when Congress was unwilling to spend money, the impact of the rapid rise in interest rates this year made it clear that the economic activity we got from ultra-low rates wasn't very high quality. That's a validation of some of the criticism of monetary policy in the 2010s. The lesson for the future is that fiscal stimulus rather than monetary policy should carry more of the load when unemployment is high and inflation is low.

The end of 2022 is a good time to revisit the era of zero-interest-rate policy because one could argue that it’s the economic activity spurred by low interest rates that’s currently in recession thanks to the Fed's aggressive increases this year. The housing market rally stalled out as mortgage rates rose to 7% from 3%. Speculative and unprofitable tech companies have seen their stock prices slump as investors steer away from risky assets in favor of bonds that now carry a decent yield. Even at profitable tech companies, investors are punishing management teams that spend a lot on unproven "science projects" that were seen as more attractive when interest rates were low. In the wake of the FTX bankruptcy, cryptocurrencies are increasingly seen as a grift rather than a growing asset class.