With inflation at 8.5%, observers are debating what the Federal Reserve did wrong. But here’s one thing the Fed did right: In August 2020, it announced a major shift in how it sets interest rates by dropping its longstanding practice of pre-emptively lifting them to head off inflation. But while that was necessary, it wasn’t sufficient.
In announcing the move, Fed officials rightly admitted there is no “exact science” for applying rigid inflation benchmarks. But they didn’t quite explain the science behind that statement. Nor did they point to historical precedents that show why reliance on the measured inflation rate can lead to bad decisions, especially in time of war or a comparable crisis like the Covid pandemic.