A central lesson of economics is that there’s rarely such a thing as a free lunch. Most policy choices involve trade-offs or benefit some people while incurring costs on others. Every so often, exceptions arise—cases of market failures owing to asymmetric information or incomplete markets—in which the government can improve welfare for all. But most of the time, state intervention in markets creates winners, losers, and distortions. Behaviors change in response to policy, creating long-term costs and unintended consequences.

This guiding principle is notably absent from most economic policymaking today. Instead, policymakers operate under the assumption that government intervention is always a net good, even if it is poorly designed. In recent years, members of Congress have not only cited Modern Monetary Theory but acted on its recommendations. During the pandemic, the federal government sent no-strings-attached checks to almost everyone and expanded unemployment insurance without considering how these policies would discourage work or worsen inflation (let alone answering who might pay for it one day). Meantime, the Fed pursued a loose monetary policy to prop up financial markets and bought many of the bonds being issued.

Some of these decisions were justified, at least at the height of the pandemic. But now we’re seeing the consequences: a labor shortage and inflation at a 40-year high. In such circumstances, the Fed’s unpleasant job is to raise rates and take air out of the economy. Currently, inflation is 7 percent, and the unemployment rate is down to 4 percent—by any definition, the economy is running hot. And yet nominal interest rates remain at zero, and the Fed is still buying long-term bonds (once considered an emergency measure).

As Fed chairman Jerome Powell noted recently, the central bank plans to increase rates this year. But, he admits, the hope is to bring monetary policy to “neutral”—that is, when the federal-funds rate equals the natural rate of interest. Neutral monetary policy will not have much impact on the labor market or inflation expectations, however, and the Fed has not explained why negative real interest rates count as neutral. The Fed is shirking its duty to contain the fallout from one of the biggest government interventions in American economic history. By slowly heading to neutral, the central bank apparently hopes that inflation will right itself. If it just lightens its foot on the gas, no harm will come to the labor market or to asset prices.

This represents an important shift. After decades of magical thinking, economists came to accept in the 1980s that monetary policy, too, involved trade-offs. The economy can’t run hot indefinitely without causing a mess, and cleaning it up means even more pain. As Raghuram Rajan, a finance professor and former Indian central banker, notes, developed economies created mechanisms—balanced budgets, inflation targets—to guard against the temptation to ignore trade-offs. Yet we seem to be suffering from a collective amnesia, once again hoping inflation will right itself once the economy returns to form and supply-chain disruptions are resolved. Inflation often starts with a supply shock, but once it takes hold it is hard to shake.

Who knows? Maybe this time will be different. Maybe inflation will moderate on its own, despite loose-to-neutral monetary policy. Maybe shutting down the economy and then pumping it full of cash won’t distort labor markets and supply chains for years to come. But odds are we won’t be so lucky. Policymakers will then have to relearn the hard way that there is no such thing as a free lunch.

Staff photo by Brianna Soukup/Portland Press Herald via Getty Images


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