How can the Fed make monetary policy serve main street as well as Wall Street? Thomas Palley argues that the Fed needs to develop new tools to offset the issues caused by low-interest rates to mitigate risks to economic stability without hurting growth.
In a famous 1955 speech, William McChesney Martin, the legendary Chairman of the Federal Reserve, declared that the Federal Reserve “is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.” Martin’s characterization of the Fed and monetary policy is brilliant and enduring. It explains why the stock market celebrates when the Fed stays on “hold”, and why the market is prone to a tantrum when the Fed raises interest rates. Staying on “hold” means more punch, while raising rates may mean sobering up.
This paper uses the punch bowl metaphor to explore and illustrate monetary policy, to show what the Fed has been doing with the punch bowl, and to suggest how it might do things better in the future. The essence of the argument is that, for thirty years prior to the financial crisis of 2008, the Federal Reserve ran the economy with too much unemployment and slack, contributing to wage stagnation and income inequality. That undermined the aggregate demand generation process, necessitating monetary policy fueled debt and asset price bubbles to fill the demand shortage. The combination of inequality and debt bubbles has proven disastrous, creating mountainous debt burdens. We need a new model for monetary policy (i.e. a different way of managing the punch bowl) that delivers full employment with wage growth, while restraining excessive debt accumulation.