The Mercatus Center has just published an excellent new working paper by Robert Hetzel.  Here’s the abstract:

In response to the pandemic, which unfurled starting in March 2020 and raised unemployment dramatically, the FOMC adopted a highly expansionary monetary policy.  The policy restored the activist policy of aggregate demand management that had characterized the 1970s.  It did so in two respects.  First, the FOMC rejected the prior Volcker-Greenspan policy of raising the funds rate preemptively to preserve price stability.  Second, through quantitative easing, it created an enormous amount of money by monetizing government debt.  In the 1970s, activist policy was destabilizing.  Reflecting the “long and variable lags” phenomenon highlighted by Milton Friedman, a temporary reduction in unemployment from monetary stimulus gave way in time to a sustained increase in inflation.  In response, the succeeding Volcker-Greenspan FOMCs rejected an activist monetary policy in favor of a neutral policy.  That policy concentrated on achieving low trend inflation and abandoned any attempt to lower unemployment by exploiting the inflation-unemployment trade-offs promised by the Phillips curve.  The success or failure of the FOMC’s activist monetary policy offers yet another opportunity to learn about what kinds of monetary policies stabilize or destabilize the economy.

Hetzel has closely followed Fed policy for many decades, and has a deeper understanding of how the Fed works than almost anyone else I know.  In 2020 and 2021, Hetzel saw many warning signs in the statements made by Fed officials, which emphasized the need to run the economy hot in order to create jobs.  I initially dismissed these statements as empty rhetoric to please politicians and pundits, and instead focused on the Fed’s commitment to its new “flexible average inflation targeting” policy, which would assure an average inflation rate of 2%.  It turns out that I was wrong and Hetzel was right—the 1960s-era views expressed by Powell and other Fed officials were the real policy, and FAIT was just empty rhetoric.

You might argue that lots of people saw the inflation coming, so why focus on Hetzel?  What makes Bob Hetzel so unusual is that he also correctly diagnosed the Fed’s policy errors back in 2008, a time when Fed policy was too contractionary.  Many of the people who worried about inflation in 2021 were permahawks, who were right in 2021 but totally wrong in 2008.  There are only a tiny number of people who correctly called Fed mistakes in both cases (Tim Congdon and Lars Christensen also fall into this group.)  Permahawks will be right when policy was (ex post) too easy, and permadoves will be right when policy was too tight.  Yawn.

In a rational world, this record of success would lead people to take Hetzel’s views much more seriously.  I hope his paper is read by professional economists who wish to learn why they got things wrong in 2008, or in 2021.  I worry that people tend to dismiss relatively non-technical studies where the analysis is informed by a deep knowledge of monetary history.

Please read the whole thing.