Federal Reserve observers watched in near disbelief last week as the US Central Bank declined to scale back the amount of money that the Central Bank prints and hands over to holders of US Treasuries and Mortgage Backed Securities, an action known in contemporary economic parlance as tapering. The decision to continue this program seems to indicate that the Federal Reserve sees downside risks in the economy continuing for the foreseeable future.
In observing the Federal Reserve's recent actions, we can now confirm that the economy currently faces unimaginable upside risks, as Central Bankers are paradoxically always the last to react to market realities which they have unwittingly created.
The Federal Reserve and many of their observers labor under a belief that is both accurate and misguided all at once. It is true that the Federal Reserve, in regulating short term interest rates as well as the base money supply, has nearly unchecked influence on the level of economic activity anywhere that dollars are used in exchange.
They are wrong in thinking that the Federal Reserve is clairvoyant in any sense of the word and can somehow time their interventions to achieve desired effects on the underlying economy. In this sense, the Federal Reserve is always the last to react as it has no idea what the true timing of the cause and effect of their policy decisions are. While they have produced reams of academic work to prove their theories, in practice, it is nothing more than guesswork with the benefit of hindsight.
The Federal Reserve will only decide to taper when nobody cares whether or not they taper, meaning that tapering will only occur when there is so much money flooding the system that the dangers are clearly on the side of hyperinflation. Inflation, in their mind, is much easier to fight than the deflationary spiral the Lehman event triggered five short years ago.