Monetary policy continues in disarray and the Federal Reserve continues to act as though it can micromanage the economy by fine-tuning interest rates. Following its October announcement that it expects to keep rates low until at least 2015, it recently announced adoption of a policy that it will not increase interest rates until unemployment falls to 6.5% or inflation increases to 2.5%. This represents a return to monetary policy based on the Phillips Curve, the notion in economics that there is an inverse relationship between the rate of unemployment and the rate of inflation in the economy. This theory was refuted 30 years ago when the Volcker Fed crushed inflation, defeated “stagflation”, and, along with Reagan’s supply side fiscal policy, launched the longest peacetime economic expansion in our history. And it was done without “managing” interest rates, but rather by managing the money supply to protect the value of the dollar and allowing rates to move with the market. It’s incredible that we are going back to such an outdated theory. Tying monetary policy to unemployment doesn’t work and is also dangerous for the economy. But what else is new for this administration?
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