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Federal Reserve’s proneness to mistakes could be detrimental, potentially leading to a recession

After Lehman Brothers’ 2008 bankruptcy precipitated the Great Recession, the Federal Reserve faced criticism for neglecting the housing market bubble and subprime lending issues. The Fed also underestimated the significance of Bear Stearns’ troubles in signaling a strained banking system. Given the policy mistakes made by Jerome Powell’s Fed, there’s concern that it may once again be accused of failing to address an impending economic crisis in the future. People may question why the Fed continued to raise interest rates without considering the time it takes for monetary policy to have an impact. Furthermore, they may wonder why the Fed ignored the effects of its own money supply and the financial-market strains it caused, as well as the unfolding Chinese economic crisis with implications for a global recession. Desmond Lachman, a columnist at the Post, suggests that Powell’s decisions could lead the United States into another recession.

One characteristic of the Powell Fed is its strictly data-dependent monetary policy, basing interest-rate decisions on current economic indicators such as wage and price inflation, economic growth, and employment rates. However, it is known that it takes 12 to 18 months for interest rate hikes to fully affect the economy. Therefore, prudence would suggest that after raising rates by 5 percentage points in just one year, the Fed should wait to assess the economic impact before taking further action. If the Fed had followed Milton Friedman’s teachings that inflation is a monetary phenomenon, it could have avoided the high inflation experienced in 2022, as it allowed the broad money supply to increase by 40% between 2020 and 2021. However, the Fed is now contracting the money supply at an unprecedented pace, potentially leading to economic weakness and a new inflationary period.

The commercial property sector, already troubled, poses additional strains on the banking system due to high interest rates and increased vacancies resulting from remote work arrangements in the post-COVID world. Over the next two years, around $500 billion in loans in this sector will need to be refinanced, adding to the potential risks. Despite these looming problems in the financial system, the Fed continues to raise interest rates without acknowledging these risks in its policy statements. President Joe Biden rightly called the Chinese economy a “ticking time bomb” after its property and credit market bubble burst. The Chinese economy is the world’s second-largest and was a major driver of global economic growth until recently. However, the Fed seems to overlook these real external economic risks, as evidenced by Powell’s failure to mention the Chinese economy as a risk worth monitoring in his recent speech in Jackson Hole.

If the United States falls into a recession next year due to a series of Fed policy mistakes, it is likely that the Fed will defend itself by claiming that nobody could have anticipated the recession. Desmond Lachman, a senior fellow at the American Enterprise Institute, previously held positions at the International Monetary Fund and Salomon Smith Barney as an expert in emerging-market economics.

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