For a long time, the US Federal Reserve has played the leading role in managing the country's economy. Its technocrats have sought to keep growth on a stable trajectory, primarily by moving a single interest rate up and down – in a process largely insulated from the pressures of electoral politics.
Now, though, the severity of the coronavirus crisis is placing more of the burden on Congress and the White House. As a result, stabilization policy is likely to get, and stay, a lot more politicized.
Last month, the Fed took its interest-rate target about as low as it can go -- to 0.1 percentage point -- in an early effort to mitigate a sharp economic downturn. With epidemiologists forecasting that some form of social distancing will persist through 2022, the Fed probably won't be raising interest rates anytime soon.
It's even possible that the Fed's target will stay near zero throughout the 2020s. Even before Covid-19 showed up, economic growth hadn't been strong enough to generate adequate inflation, which remained below the central bank's 2% target for most of the 2010s. As a result, inflation expectations have decreased: Investors are betting that the Fed's preferred measure of inflation will average less than 1% over the coming decade. To prevent those expectations from falling further, and to avoid a decline into damaging deflation, the Fed will have to be very careful about raising rates.
As long as the Fed stays pinned at the "zero lower bound," economic policy will work very differently. For the past 40 years, the central bank's unelected technocrats have been able to fight recessions relatively free of politics, because they have focused on whether to toggle a single policy instrument – short-term interest rates – up or down. Now, the government will have to step in with fiscal policy – that is, spending financed by sovereign borrowing. Its tools come in all shapes and sizes, and the choice among them will be highly political.
Consider the initiatives by Congress and the White House to rescue people and companies slammed by measures to contain the pandemic. So far, their efforts have tilted toward large corporations. But there's a strong argument to provide more support for individuals – for example, by sending out payments of $12,000 per person instead of the $1200 promised in the Cares Act. How politicians choose among such fiscal measures depends on their ideology, and that of their voters and donors.
The Fed will still have a role. But it will probably be more fiscal, too. Consider how Congress chose to finance emergency lines of credit to large corporations. It could have borrowed the money by issuing Treasury debt. Instead, it decided merely to provide a backstop to the Fed, which might end up lending as much as $4 trillion. I wouldn't be surprised to see a lot more similar cooperation, in which the central bank uses its money-creating power to support Congressional fiscal policy. One can only hope that this connection doesn't lead to inflationary pressures of the kind that the US saw in the 1970s.
More broadly, with elected officials taking the lead, economic stabilization policy will be subject to the same dynamics of politicization and polarization that have obstructed Washington's decision-making in so many areas. I expect that we'll come to miss the good old days, when the technocrats at the Fed were in charge.
Narayana Kocherlakota is a Bloomberg Opinion columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.
Disclaimer: This article first appeared on Bloomberg.com, and is published by special syndication arrangement.