The Fed can learn from history’s blunders

By Barry Eichengreen

One of the chief ways financial market participants make sense of events is by drawing parallels with the past. The subprime crisis, when it first erupted, was widely perceived as the most dangerous financial crisis since the 1930s. The implication was that it was critical to avoid the policy mistakes that transformed that earlier crisis into a macro­economic disaster. The lesson drawn was that it was important to avoid an excessively tight monetary policy.

Now, with inflation rising, the popular parallel is not the deflationary 1930s but the stagflationary 1970s. Again the implication is that it is important for policymakers to avoid past mistakes. In this case past mistakes mean a monetary policy that allows inflation expectations to become unanchored.

In fact both analogies are misleading, precisely because market participants and policymakers are aware of this history. Their awareness means that financial history never repeats itself in the same way. Biochemists can replicate their experiments because molecules do not learn. Central bankers lack this luxury.

The remainder of this column can be read here. Debate from our panel of economists appears below.

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