The Fed Is Back in Its Pre-Recession Pickle

The Federal Reserve has had its share of drama over the past 12 years, during a credit bubble, bust and recovery. This prompted emergency measures like quantitative easing, followed by a ballooning balance sheet that is now starting to shrink. Yet despite all that drama (and some cast changes), the Fed finds itself back in the same box it was in during the middle of the last decade. This suggests a structural limitation on the institution's power, with no clear remedy.

That "box" is the quandary of how the Fed should respond to the dynamics of late-cycle economic expansions. As in the middle of the last decade, the Fed is concerned about an overheating economy. Back then, the fear stemmed from the booming housing sector. (Now the concern is a labor shortage -- with increased immigration politically unlikely and with the unemployment rate already down to 4.1 percent, below the Fed's longer-run projection of 4.6 percent.) Financial conditions were very loose, making the Fed think that overheating risks would become even more pronounced in the future.