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The Federal Reserve Should Give Wall Street a Shock

Author: Sebastian Mallaby, Paul A. Volcker Senior Fellow for International Economics
March 7, 2017
The Washington Post

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Prudence and predictability are not exactly plentiful in President Trump’s Washington. But sometimes there can be too much of these virtues, and that is the danger confronting the Federal Reserve under Janet Yellen.

When Yellen and her colleagues meet next week, Wall Street confidently expects them to nudge interest rates up by a quarter of a percentage point, a move that would acknowledge the strength of the economy yet avoid kicking over the apple cart with a more brutal adjustment. But, contrary to conventional wisdom, the central bank should want to spill some apples. Wall Street is complacent. It could use a surprise kick.

To see why this is so, start with some quick history. For half a century after World War II, U.S. recessions came about because spending grew faster than production, inflation picked up, and the Fed had to raise interest rates and choke growth to force inflation down again. That changed in the 1990s. Globalization and technological advances put a lid on inflation: Cheap imports restrained prices; the ability to replace workers with machines checked wages. Meanwhile, the Fed under Alan Greenspan convinced everyone that inflation had been permanently vanquished, which further dampened the old habit of marking up prices.

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