Karen Petrou: When Economic Theory Meets Political Reality

2023-06-01T14:58:22-04:00November 8th, 2021|The Vault|

In a thought-provoking column on Friday, former Federal Reserve Bank of Minneapolis President Kocherlakota asked if the Fed is playing politics with interest rates.  As he points out, this is a troubling prospect, albeit wholly an unproven one.  What doesn’t need proof, though, is that interest rates are playing a deadly game with politics.  Last Tuesday, economic theory met political reality in yet another collision in which voters made it at least as clear as they did in 1980 that they won’t put up with low rates if they lead to high prices and the economic inequality it exacerbates.  The Fed has a profound, albeit de facto, fiscal role. Failure to reckon with it poses risks not just to Democratic officeholders, but also to the Fed itself.

Last July, Jay Powell emphatically rebutted a Member of Congress who asked him about my view that the Fed has dramatically, if inadvertently, increased income and wealth inequality.  Then as before and after, the Fed chairman asserted that economic inequality is wholly an artifact of fiscal policy.  At his press conference on Wednesday, he did express sympathy for those dealing with high prices, but he still insisted that policy relief is beyond the Fed’s reach as stipulated in its statutory mandate.

Later this month, I’ll present a paper showing that the Fed’s full statutory mandate requires attention to the “general welfare” and other equality drivers.  I’ll also lay out how seemingly pure monetary policy has become a real, dominant fiscal power by …