Monetary Policy and Schrödinger's Cat
Barry Eichengreen warns us that there is more to evaluating and conducting policy than picking the correct historical analogy:
"One of the chief ways financial market participants make sense of events is by drawing parallels with the past. The subprime crisis, when it first erupted, was widely perceived as the most dangerous financial crisis since the 1930s. The implication was that it was critical to avoid the policy mistakes that transformed that earlier crisis into a macroeconomic disaster. Specifically, it was important to avoid an excessively tight monetary policy.
Now, with inflation surging, the popular parallel is not the deflationary 1930s but the stagflationary 1970s. Again the implication is that it is important for policymakers to avoid past mistakes. This time, however, past mistakes means a monetary policy that allows inflation expectations to become unanchored.
In fact both analogies are misleading, precisely because market participants and policy makers are aware of this history. Their awareness means that financial history never repeats itself in the same way. Biochemists can replicate their experiments because molecules do not learn. Central bankers lack this luxury."
"The Fed’s mistake was cutting interest rates so dramatically when it expanded its credit facilities. Better would have been to lend freely at a penalty rate, a la Bagehot. Higher interest rates which made its emergency credit more costly would have meant better targeted lending and less inflation."