The Fed’s Policy Mistake

Fed’s policymakers overestimated the negative output gap, leading them to prolong the monetary expansion beyond the necessary during the pandemic. The prolonged money expansion contributed to fuel inflation during the post-recession rebound. The policy mistake was the result of an inaccurate estimation of potential output. This paper shows that the economy has developed a positive output gap based on an alternative estimation that uses full employment as a condition. The results illustrate that the Federal Reserve is behind the curve in an economy in overexpansion