Looking at never ending financial crises should lead one to ask who is responsible for all that mayhem, with excessive price inflations, unstable economic growth, staggering public debt and the dollar’s eroding position as a reliable store of value?

The answer that Democrats or Republicans take that responsibility by losing elections during major cyclical downturns is deceptively simple, as shown by the following exchange.

In the early 1990s, a bitterly disappointed former president rejected the charge that his election loss was a sanction of his bad economic management. He squarely put the blame on the Federal Reserve’s tight monetary policy.

And then the plot thickened as the Fed accused the ex-president of meddling into an independent policy domain.

That blame-shifting episode suggests that the answer we were looking for is unambiguous: The Fed is the unique locus of responsibility for America’s economic policy.

How about external shocks or irresponsible fiscal policies? Can the Fed prevent their destabilizing inflationary impact?

The Fed must be held accountable for its policy errors

The answer is yes. Exogenous shocks, whatever they are, or mistaken tax and public spending policies can only lead to accelerating price inflations if they are validated by an accommodative credit creation.

But can the Fed refuse bailouts and focus on price stability?

Of course, it can. First, the Fed’s “dual mandate” for price stability and maximum sustainable employment is not contradictory, because the full employment, or anything approximating that policy objective, is impossible in an inflationary environment. Second, the Fed is an independent agency accountable to the U.S. Congress – not to the U.S. Treasury or the White House.

The Congress exercises its regulatory and supervisory authority through testimonies of Fed’s governors and a scrutiny of Fed’s biannual monetary policy reports.

It follows, then, that the U.S. Congress systematically approved the Fed’s disastrously loose monetary policy that led to the 2008 financial crisis, and to ensuing bailouts to prevent the collapse of the financial system and to manage the ravages of the Great Recession.

And the Fed’s extraordinarily huge credit creation did not stop there. With the Congressional nod, the Fed proceeded with its four rounds of “quantitative easing” between 2008 and the March of 2020 to support the economy.

The result of all that is: (a) an explosion of a mostly Fed monetized American public debt from 73% of GDP in 2008 to 128% of GDP at the end of last year, and (b) a headline consumer price inflation of 8.5% in the year to last July, with its core component (excluding food and energy) reaching 6%.

Inflation was ignored during those 14 years of an exceptionally huge monetary expansion. And that attitude continued to prevail even when the Fed’s picked inflation indicators began to signal alarmingly consistent demand-supply imbalances in labor and product markets.

November elections are a crucial event

The time to act, for example, was in March 2021, when the core PCE (personal consumption expenditure) index hit 2% from 1.5% in the previous month, and then jumped to 3% during April. The Fed peremptorily dismissed all that as “transitory and reversible” events.

The Fed then waited until March of this year to begin raising the federal funds rate from 0%. But by that time, the core PCE was at 5.2%, more than double its medium-term target.

The Democrat controlled Congress -- fixated on November’s mid-term elections and on the presidential run in 2024 – apparently had no problem with Fed’s inaction, based on the claim of “transitory and reversible” inflation developments caused by volatile energy prices.

Predictably, that just made things worse because the rising energy costs were moving up a broad range of prices in labor and product markets. Those second-round price effects have now created a situation where aggregate demand will have to be brought down to restore a sustainable balance with deficient sources of supply.

Indeed, with unit labor costs surging at an annual rate of 9% in the first half of this year, it will take a long period of rising interest rates and declining demand pressures just to stop the ongoing inflationary flare-up.

At the moment, the Fed is at the beginning of that process. With the nominal short-term interest rate of 2.8% and an inflation rate of 8.5%, the Fed’s real policy interest rate is still a hugely expansionary minus 5.7%.

There is, therefore, a long way of growth recession and rising unemployment to bring the monetary policy to a neutral position, where the policy interest rate should be +2%. But such a recessionary scenario is completely incompatible with the Democratic party’s political interests. And that could only change if the mid-term Congressional elections were to radically modify the current configuration of legislative power.