What Would The "Old Fed" Do Today?
What would the "Old Fed" do today? In 2021, nominal GDP recorded the first double-digit annual growth since 1984. Yet, the two stunning nominal growth performances saw opposite responses from monetary policy. In 1984, the Federal Reserve raised official rates several hundred basis points to a level roughly equal to nominal GDP growth, while in 2021, policymakers continued to easy monetary policy.
That begs the question, since monetary policy creates nominal GDP, what would the "Old Fed" do today?
First, at the January 25-26 Federal Open Market Committee (FOMC) meeting, the "Old Fed" would have ended the asset purchase program, arguing that the stance of monetary policy is too accommodative. The current Fed merely announced its end in March, and as a result, continues to ease policy in the face of rising inflation pressures.
Second, the "Old Fed" would have shocked the market with an official rate increase (25 or 50 basis points) at the January meeting. The justification for the policy move is that monetary policy is more accommodative in January 2022 than at any time during the pandemic. The current Fed hints at an official rate hike at the next meeting in March, maintaining the most accommodative policy in decades.
Third, the "Old Fed" would argue that the hike in official rates is warranted because tight labor markets and fast-rising wages threaten to sustain the inflation cycle. The current Fed merely talks about raising rates due to robust labor markets and is still unsure it hit the maximum employment mandate.
Fourth, the "Old Fed" would announce an immediate and sharp shrinkage in the Fed balance sheet to bring about a quick return to a more normal stance of monetary policy. The current Fed started "introductory discussions" of balance sheet reduction and probably will not begin any shrinkage until mid-year. Thus, monetary policy will remain overly accommodative.
Fifth, the "Old Fed" would not be bound by any rigid rules of only announcing a policy change at regularly scheduled meetings. The "Old Fed" would be more proactive, arguing the best way to maintain a stable macro environment is by being preemptive. And that would include making policy changes between regularly scheduled meetings. The current Fed is committed to announcing policy changes at regularly scheduled meetings. Following these rigid rules means policymakers will fall further behind the curve.
By raising rates quickly and dramatically, the "Old Fed" engineered a soft landing in late 1984 and 1985. What are the chances the current Fed can do the same? In my view, the odds are very low.