Haunting the Fed in 2021: The Mistake of 1937

History provides great lessons from the past. Unfortunately, many don't want to follow the past and maintain the "this time is different" view. Alternatively, history can also haunt us. We may be constrained by our inability to leave history behind.

I am worried about Fed complacency about inflation. Inflation is only transitory ex post. At zero nominal short rates, negative real rates, and $120 billion in Treasury buying a month, there is significant excessive monetary stimulus. Talk is growing about the Fed having to do something in the face of inflation, yet early action has its own downsides. There are no good choices; however, the bias is to have everyone take the pain from inflation instead of a stalled recovery.

So what can we pull from past Fed history that may can give us some insight on current Fed thinking? A relevant piece of history is the "Mistake of 1937". (See "Commodity Prices and the Mistake of 1937: Would Modern Economists Make the Same Mistake?" from the NY Fed Liberty Economics blog for any interesting review.) The policy mistake was a premature tightening by the Fed based on rising commodity prices and the belief that the US economy was in recovery. It wasn't, and Fed action pushed the Great Depression economy back into an economic downfall that was only reversed by World War II.

We have similar signs today; improvement in the economy and strong increases in commodities. The Fed does not want to fall into a 1937 trap, so they may be more conservative toward any change. I can appreciate this view. I am not making a normative judgment that this is the correct or wrong view. I do believe the haunting of 1937 may cause a policy delay, so investor should be ready for the consequences.