By Anatole Kaletsky
Don’t fight the Fed
Such a conclusion seems obvious—except to financial traders subject to a third cognitive bias: “Don’t fight the Fed.” This favorite market saying asserts that once the U.S. central bank gets serious about achieving an objective, such as an inflation target, investors should always assume that it will get its way.
This makes sense when the Fed is genuinely prepared to do whatever it takes to meet its goals, for example by clearly pursuing low inflation regardless of the effect on unemployment, stock markets, and debt-servicing costs. But today’s Fed is so focused on “well-anchored” inflation expectations that it is quite relaxed about “backward-looking” data that continue to show prices rising much faster than most businesses and workers have ever seen.
Nothing new under the sun
That leads to a final bias: Most people find it difficult to imagine events that have never happened in their lifetimes. For many investors and policy makers, stubbornly high inflation falls into this category. Market wisdom expresses this bias with the adage that “there are no new eras.”
But new eras do happen, as the world learned painfully in 1973. And today’s interaction of Russia and COVID-19 with monetary and fiscal expansion has created unprecedented conditions, which guarantee that the period ahead will be very different from the past 40 years.
The question is whether the new era now dawning will be dominated, for the first time in a generation, by persistently rapid price growth; or whether, for the first time in history, we will painlessly overcome an inflationary crisis with negative real interest rates and without the collateral damage of a major recession. Markets and central banks confidently expect a new, carefree epoch. If they are right, we can all live happily ever after.
Anatole Kaletsky, chief economist and co-chairman of Gavekal Dragonomics, is the author of “Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis” (Public Affairs, 2011).
This commentary was published with permission of Project Syndicate — Why Are Financial Markets So Complacent?
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