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    opinion | Niall Ferguson

    The Fed has awakened the Force, but beware the Dark Side

    Traders worked on the floor of the New York Stock Exchange as a television screen displayed coverage of the Federal Reserve raising interest rates on Wednesday.
    Traders worked on the floor of the New York Stock Exchange as a television screen displayed coverage of the Federal Reserve raising interest rates on Wednesday.

    The Force awakens. For the first time since the financial crisis — for the first time, indeed, since June 2006 — the Federal Reserve has raised interest rates. Traditionally, stock markets do not celebrate a tightening of monetary policy, but in the immediate aftermath of the Fed’s announcement on Wednesday, there was a brief worldwide rally.

    Not for the first time, the masters of the universe (that’s the people who get paid in hundreds of millions) raised their Dom Perignon-filled glasses to the lords of finance (the much more modestly compensated people who run the world’s major central banks). Janet Yellen, chair of the Federal Reserve, garnered reviews almost as good as the new “Star Wars’’ movie.

    All this good cheer recalled the heady days of the pre-crisis era, when an earlier cohort of central bankers were toasting themselves for having solved the world’s economic problems. In February 2004, Ben Bernanke (then a member of the Fed’s board of governors) gave a memorable lecture entitled “The Great Moderation,” in which he made the claim that “the substantial decline in macroeconomic volatility over the past 20 years” was in large part due to “improved monetary policy.” This conclusion, he said, made him “optimistic for the future.” In those bygone days, the central bankers were the monetary Jedi Knights, triumphant victors over the Darth Vader of stagflation.


    By the summer of 2006 — by which time Bernanke was Fed chairman — it was becoming clear to a tiny number of commentators (myself among them) that an increasingly indebted and over-complex financial system, regardless of a succession of Fed rate hikes, was about to strike back. By late 2008, following the blow-up of Lehman Brothers (the Death Star of Wall Street), the Great Moderation looked like it was becoming a second Great Depression.

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    Credit where it is due. Bernanke, whose academic work had luckily focused on the Great Depression, responded to the crisis with alacrity and imagination. He and his counterparts slashed interest rates and, when those hit zero, embarked on large-scale purchases of bonds and other securities — so-called quantitative easing, or QE — intended to simulate the effect of further rate cuts.

    The Fed “tapered” QE last year; now it has ended its zero-interest-rate policy, or ZIRP. Even if QE and ZIRP sound to you like the noises emitted by R2-D2, you are still entitled to ask: Is the crisis finally over? According to the Fed, it is: “Economic activity has been expanding at a moderate pace,” declared Wednesday’s statement.

    Unfortunately, even before the statement was released, its reasoning was demolished by the man who — had Barack Obama shown more resolve in 2013 — would now be sitting in Janet Yellen’s chair: Larry Summers. As he pointed out on Tuesday, inflation is well below the Fed’s 2 percent target and there is not much evidence of its accelerating, especially with oil prices continuing to slide.

    So who is right? The truth is that, in its present state, economics cannot tell us for sure.


    The most persuasive argument against a Fed rate hike, in my view, is the historic decline of global real interest rates since the 1980s. But how can we explain this decline? In an important new paper, economists Lukasz Rachel and Thomas Smith offer a veritable laundry list of possible explanations that includes, on the one hand, rising inequality and changing demographics (which have boosted global saving) and, on the other, lower costs of capital goods and greater “short-termism” (which have reduced global investment). The problem with this explanatory framework is that — as one leading central banker put it to me recently — “it tells us that the things that really matter are the things we don’t know much about.”

    The “new Keynesian” macroeconomic models that are the foundation of modern monetary policy failed to predict the crisis and failed to anticipate its duration. The reason for their failure is now clear: In order to achieve mathematical elegance, they had left out the things that turn out to be crucial.

    A favorite topic of discussion among central bankers is the need for greater transparency. Where once their utterances were infrequent and gnomic, they now inundate us with statements, each sentence of which is dissected the way Star Wars nerds analyze the sayings of Yoda.

    But no one has yet publicly admitted that the lords of finance have no clothes — or, at least, no working models. I suppose this is because the masters of the universe, as they make or lose their billions, need to believe that somebody is in charge and knows what they are doing, while the central bankers dare not set them straight. Imagine becoming a Jedi, only to discover that there’s no such thing as the Force. Scared you would be.

    Niall Ferguson is professor of history at Harvard University and a senior fellow of the Hoover Institution.