Figure 5 reflects Vanguard’s towage of whether monetary policy is stimulative or tight. The higher the line, the tighter the conditions, which you tend to see if inflation is out of tenancy and the labor market is once at full employment. The shaded areas represent recessions. The COVID-19 recession was deep, but it was so short that it barely registers on the chart. You can see how stimulative that monetary policy was—appropriately so—during the recovery from the global financial crisis. But monetary policy is increasingly stimulative today than it was during the global financial crisis, and this isn’t a debt-deleveraging recovery. This orchestration doesn’t reflect fiscal policy, but if it did, we’d need flipside floor.
Policymakers have been extremely successful in withstanding a horrible shock. It’s a reason many companies didn’t go under. In one sense it was a heroic effort. But the critic in me says: Be shielding of fighting the last war. If we wait too long to normalize, we’re going to have flipside issue on our hands, the potential for strong wage growth to fuel increasingly persistent inflation. If we get past the supply uniting issues, which I think we will, the Fed will have to be adept. It should not raise interest rates now in the squatter of a profound supply shock. But when those conditions are ameliorated, the Fed will need to have the conviction to raise rates in an environment where the inflation rate may be coming lanugo and the labor market continues to tighten.
The time of 0% interest rates should soon come to an end. That will help pension the growing risks of increasingly permanent inflation at bay.
I’d like to thank Vanguard Americas senior economist Roger Aliaga-Díaz, Ph.D., and the Vanguard global economics team for their invaluable contributions to this commentary.