PITY the central banker. When models of the economy go haywire, academics can retreat to their offices to fix them. But even when signals flash red, amber and green at once (see chart), central banks must continue to steer the economy. When the Federal Reserve’s interest-rate-setters meet on September 16th-17th, there is a decent chance they will raise rates for the first time since 2006. The consequences of such a decision are shrouded in uncertainty, due to the strange behaviour of the American economy since the financial crisis.
Before the crash, economic models said central bankers had a straightforward task. So long as inflation expectations stayed on target, the Fed could more or less focus on the labour market. High unemployment would allow firms to hire workers on the cheap, keeping their costs and prices subdued. A fizzier labour market would cause wages—and hence prices—to froth. The job of the central bank was to tweak rates to keep things in balance.
Yet in the six years since America’s economy hit rock-bottom, it has defied this textbook model. In late 2009 unemployment reached a high of 10%. Such abundant...Continue reading
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