Former Fed vice chairman Alan Blinder warns of the dangers of slowing the central bank’s printing presses too early and thereby repeating the mistakes of the mid-1930s. As he explains,
From its bottom in 1933 to 1936, the G.D.P. climbed spectacularly (albeit from a very low base), averaging gains of almost 11 percent a year. But then, both the Fed and the administration of Franklin D. Roosevelt reversed course.
In the summer of 1936, the Fed looked at the large volume of excess reserves piled up in the banking system, concluded that this mountain of liquidity could be fodder for future inflation, and began to withdraw it. This tightening of monetary policy continued into 1937, in a weak economy that was ill-prepared for it.
Blinder is right to warn against ending the liquidity injections too early. But that doesn’t mean the party should go on forever. In a sign of the times, however, Blinder’s mum on identifying that magic day in the future when the ambitious expansion of the money supply and the Fed’s balance sheet should end and the monetary tightening should begin. He’s quiet on this point for a very good reason: He doesn’t know the date. Nor does anyone else, and therein lies the great challenge confronting the U.S. economy, and one that Blinder avoids discussing in his otherwise salient article on Sunday in the New York Times.