The Fed’s Scylla and Charybdis

TILBURG – While the advanced economies have been struggling through the worst economic crisis in decades, their central banks have had it easy. After all, when faced with falling GDP growth, a financial system on the verge of collapse, plummeting real-estate prices, and a lack of consumer confidence, the needed monetary-policy response is clear: keep lowering nominal interest rates until they reach the zero bound, then pull out the big, unconventional guns.

But, for the US Federal Reserve, the easy part is over.

When the Fed launched its first round of quantitative easing (QE) – large-scale purchases of long-term financial assets – in 2009, policymakers declared that the goal was to kick-start the US economy. Once that was achieved, the Fed vowed, it would terminate the scheme. Now, with the US economy growing at a steady annual rate of roughly 2%, real-estate prices rising, consumer confidence at a six-year high, and gradual recovery in the labor market, the time has come for the Fed to follow through on its promise.

To be sure, the US economy is not performing at pre-crisis levels. But recent developments herald the “post-crisis” era – and that means that QE’s objective has been fulfilled. To use former Fed Chairman William McChesney Martin’s metaphor, the party has gotten going again, so the Fed must take away the punch bowl.