KW: The Fed cut interest rates to zero in 2008 in a frenzied response to the financial crisis. When that was not enough to stop the panic, so the Fed began quantitative easing, or QE, which lifted the stock market. The Fed began raising rates in Dec. 2015 and began quantitative tightening (QT) in Oct. 2017.
But after markets almost entered a bear market in December, the Fed has done an about face. It is pausing on rate hikes and is winding down QT, far ahead of earlier plans. Here’s why additional monetary tightening may be impossible without causing a possibly devastating recession. In other words, central banks may be stuck at zero indefinitely (or, in the Fed’s case, returning to zero) in order to prop up growth.
The valid insight behind “modern monetary theory” – that governments and central banks together can always create nominal demand – was explained by Milton Friedman in 1948. But it is vital also to understand that excessive monetary finance is hugely harmful, and it is dangerous to view it as a costless way to solve long-term challenges.