In addressing the economic and financial fallout of the COVID-19 pandemic, the US Federal Reserve has not only failed to ensure price stability, but has also doubled down on the misguided approach of the post-2008 era. The result is a financial system oriented around dangerously misaligned incentives.

STANFORD – The nomination of <a href="https://www.nytimes.com/2022/01/13/business/economy/biden-federal-reserve-nominees.html" target="_blank" rel="noopener">new members</a> to the US Federal Reserve Board offers an opportunity for Americans – and Congress – to reflect on the world’s most important central bank and where it is going. 
 The obvious question to ask first is how the Fed blew its main mandate, which is to ensure price stability. That the Fed was totally surprised by today’s inflation indicates a fundamental <a href="https://www.project-syndicate.org/commentary/us-fiscal-inflation-5-trillion-stimulus-by-john-h-cochrane-2021-12" target="_blank" rel="noopener">failure</a>. Surely, some institutional soul searching is called for. 
 Yet, while interest-rate policies get headlines, the Fed is now most consequential as a financial regulator. Another big question, then, is whether it will use its awesome power to advance climate or social policies. For example, it could deny credit to fossil-fuel companies, demand that banks lend only to companies with certified net-zero emissions plans, or steer credit to favored alternatives. It also could decide that it will start regulating explicitly in the name of equality or racial justice, by telling banks where and to whom to lend, whom to hire and fire, and so forth. 
 But before considering where the Fed’s regulation will or should go, we first need to account for the Fed’s grand failure. In 2008, the US government made a consequential decision: Financial institutions could <a href="https://www.investopedia.com/news/10-years-later-lessons-financial-crisis/" target="_blank" rel="noopener">continue</a> to get the money they use to make risky investments largely by selling run-prone short-term debt, but a new army of regulators would judge the riskiness of the institutions’ assets. The hope was that regulators would not miss any more subprime-mortgage-size elephants on banks’ balance sheets. Yet in the ensuing decade of detailed regulation and regular scenario-based “stress tests,” the Fed’s regulatory army did not once consider, “What if there is a pandemic?” 
 When a pandemic did arrive in early 2020, the Fed repudiated the “<a href="https://www.federalreserve.gov/newsevents/speech/20100407a.htm" target="_blank" rel="noopener">never again</a>” promises of 2008, this time intervening on an even larger scale. That March, the dealer banks proved <a href="https://www.pimco.com/en-us/insights/viewpoints/in-depth/lessons-from-the-march-2020-market-turmoil" target="_blank" rel="noopener">unable</a> to intermediate the market for plain-vanilla US Treasury securities. So, the Fed propped up the market. Critics had long pointed to <a href="https://crsreports.congress.gov/product/pdf/R/R46411" target="_blank" rel="noopener">problems</a> with the Fed’s liquidity rules, and fixing these markets would have been simple, but obvious reforms had languished. Later, there was a run on <a href="https://www.nytimes.com/2021/04/23/business/economy/money-market-funds-reform.html" target="_blank" rel="noopener">money market funds</a>. The Fed <a href="https://www.wsj.com/articles/why-the-fed-had-to-backstop-money-market-funds-again-11584788401" target="_blank" rel="noopener">bailed out</a> money market funds once again. There is nothing simpler to fix than money-market runs, but the fix never happened. 
 The Fed also funded new <a href="https://www.brookings.edu/blog/up-front/2021/08/31/how-well-did-the-feds-intervention-in-the-municipal-bond-market-work/" target="_blank" rel="noopener">municipal-bond issues</a> and propped up <a href="https://www.cnbc.com/2020/06/29/the-fed-is-buying-some-of-the-biggest-companies-bonds-raising-questions-over-why.html" target="_blank" rel="noopener">corporate bond prices</a>, essentially offering a whatever-it-takes <a href="https://www.nytimes.com/2020/04/29/upshot/fed-powell-economy-pandemic.html" target="_blank" rel="noopener">guarantee</a>. In 2008, the Fed and the Department of the Treasury had balked at the idea of raising the market price of all mortgages under the Troubled Assets Relief Program. Yet in 2020, the “<a href="https://www.marketwatch.com/story/whats-next-for-markets-after-the-feds-powell-signals-hes-not-riding-to-the-rescue-just-yet-11614944583" target="_blank" rel="noopener">Powell put</a>” had established an explicit floor for corporate bond prices – and more. 
 The predictable rejoinder to this critique will be: So what? The COVID-19 lockdowns might well have triggered a financial crisis. The flood of bailouts worked, so much so that our problem today is inflation. We do not need to worry about systemic risk, because the Fed and the Treasury will just put out any new fires with oceans of new money. 
 The problem, of course, is the incentives these policies have created. Why bother keeping cash or balance-sheet space to buy on the dip, provide liquidity, or treat a “fire sale” as a “buying opportunity?” The Fed will just front-run you and take away the profit. If you are a company, why issue stock when you can just borrow, knowing that the government will prop up your debt or bail you out, as it did for the <a href="https://www.nytimes.com/2020/04/14/business/coronavirus-airlines-bailout-treasury-department.html" target="_blank" rel="noopener">airlines</a>? If you are an investor, why hesitate to buy shaky debt, knowing that its value will be guaranteed by another “whatever-it-takes” commitment from the Fed in bad times? 
 No wonder America is awash in debt. Everyone assumes that taxpayers will take on losses in the next downturn. Student loans, government pensions, and mortgages have piled up, all waiting their turn for Uncle Sam’s bailout. But each crisis requires larger and larger transfusions. Bond investors eventually will refuse to hand over more wealth for bailouts, and people will not want to hold trillions in newly printed cash. When the bailout that everyone expects fails to materialize, we will wake up in a town on fire – and the firehouse has burned down. 
 In 2008, regulators and legislators at least had the sense to recognize moral hazard, and to worry that investors gain in good times while taxpayers cover losses in bad times. But the 2020 blowout has been greeted only with self-congratulation. 
 The same Fed that missed the subprime-mortgage risks in 2008, the pandemic in 2020, and that now wishes to stress-test “<a href="https://www.project-syndicate.org/commentary/climate-financial-risk-fallacy-by-john-h-cochrane-2021-07" target="_blank" rel="noopener">climate risks</a>,” will surely miss the next war, pandemic, sovereign default, or other major disruptive event. Fed regulators aren’t even asking the latter questions. And while they issue word salads about “<a href="https://www.federalreserve.gov/publications/2020-november-financial-stability-report-near-term-risks.htm" target="_blank" rel="noopener">interconnections</a>,” “<a href="https://www.federalreserve.gov/econres/feds/files/2021070pap.pdf" target="_blank" rel="noopener">strategic interactions</a>,” “<a href="https://www.federalreserve.gov/publications/2021-annual-performance-report.htm" target="_blank" rel="noopener">network effects</a>,” and “<a href="https://link.springer.com/article/10.1057/s41308-020-00125-1" target="_blank" rel="noopener">credit cycles</a>,” they still have not defined what “systemic” risk even is, other than a catch-all term to grant regulators all-encompassing power. 
 Regulators will never be able to foresee risks, artfully calibrate financial institutions’ assets, or ensure that immense debts can always be paid. We need to reverse the basic premise of a financial system in which the government always guarantees mountains of debt in bad times, and we need to do it before the firehouse is put to the test. 
 Better regulation can bridge partisan divides. The left is correct that big banks are inefficient oligopolies that serve most Americans poorly. But it has the cause wrong. An immense regulatory compliance burden is a major barrier to market entry. 
 Calls for “more” regulation are meaningless. Regulations are either smart or dumb, effective or ineffective, full of undesired consequences or well designed. We need better regulation. We need more capital, not many more thousands of pages of rules. Capital provides a buffer against all shocks, and it does not require regulators to be clairvoyant. The Fed has scandalously blocked narrow-banking enterprises and payments providers that could help serve many Americans’ financial needs. 
 Before turning to healing the planet and righting injustice, the Fed should be held to account for how badly it is doing on the basic task of protecting the financial system. JOHN H. COCHRANE 
 John H. Cochrane is a senior fellow at the Hoover Institution.

Everyone assumes that taxpayers will take on losses in the next downturn. Student loans, government pensions, and mortgages have piled up, all waiting their turn for Uncle Sam’s bailout.

Why Isn’t the Fed Doing its Job?

Forecasting inflation is a staple of macroeconomic modeling, yet virtually all economists’ predictions for the United States in 2021 were way off the mark. This dismal performance reflected a collective failure to take economic models seriously enough, as well as other analytical shortcomings.

CAMBRIDGE – In 2008, as the global financial crisis was ravaging economies everywhere, Queen Elizabeth II, visiting the London School of Economics, famously <a href="https://www.dailymail.co.uk/news/article-1083290/Its-awful--Why-did-coming--The-Queen-gives-verdict-global-credit-crunch.html" target="_blank" rel="noopener">asked</a>, “Why did nobody see it coming?” The high inflation of 2021 – especially in the United States, where the year-on-year increase in consumer prices reached <a href="https://www.cnbc.com/2022/01/12/cpi-december-2021-.html" target="_blank" rel="noopener">a four-decade high of 7%</a> in December – should prompt the same question. 
 Inflation is not nearly as bad as a financial crisis, particularly when price increases coincide with a rapid improvement in the economy. And whereas financial crises may be inherently unpredictable, forecasting inflation is a staple of macroeconomic modeling. 
 Why, then, did almost everyone get the US inflation story so wrong last year? A <a href="https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/spf-q2-2021" target="_blank" rel="noopener">survey</a> of 36 private-sector forecasters in May revealed a median inflation forecast of 2.3% for 2021 (measured by the core personal consumption expenditures price index, the US Federal Reserve’s de facto target gauge). As a whole, the group put a 0.5% chance on inflation exceeding 4% last year – but, by the core PCE measure, it looks set to be 4.5%. 
 The Fed’s rate-setting Federal Open Market Committee fared no better, with <a href="https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20210317.pdf" target="_blank" rel="noopener">none</a> of its 18 members expecting inflation above 2.5% in 2021. Financial markets appear to have missed this one as well, with bond prices yielding similar predictions. Ditto the <a href="https://blogs.imf.org/2021/02/19/structural-factors-and-central-bank-credibility-limit-inflation-risks/" target="_blank" rel="noopener">International Monetary Fund</a>, the <a href="https://www.cbo.gov/publication/57339" target="_blank" rel="noopener">Congressional Budget Office</a>, <a href="https://www.whitehouse.gov/wp-content/uploads/2021/05/budget_fy22.pdf" target="_blank" rel="noopener">President Joe Biden’s administration</a>, and even many <a href="https://www.cnn.com/2021/01/21/economy/stimulus-biden-trump-hassett/index.html" target="_blank" rel="noopener">conservative</a> <a href="https://www.bloomberg.com/news/articles/2021-02-07/yellen-summers-spar-about-overheating-risk-in-stimulus-debate" target="_blank" rel="noopener">economists</a>. 
 Some of this collective error resulted from developments that forecasters did not or could not expect. Fed Chair Jerome Powell, among many others, <a href="https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20211103.pdf" target="_blank" rel="noopener">blamed</a> the Delta variant of the coronavirus for slowing the reopening of the economy and thus driving inflation higher. But Powell and others had earlier <a href="https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20210728.pdf" target="_blank" rel="noopener">argued</a> that the increase in inflation in the spring of 2021 was spurred by an overly rapid reopening as vaccination reduced case numbers. It is unlikely that both of these excuses are correct. The emergence of Delta, like the pandemic in 2020, probably kept inflation lower than it otherwise would have been. 
 Supply-chain disruptions were another unanticipated development that allegedly blew up inflation forecasts. But while the pandemic has caused some genuine bottlenecks in production networks, most are churning out much more than last year, with both US and global manufacturing output and <a href="https://twitter.com/jasonfurman/status/1469406042488549380?s=20" target="_blank" rel="noopener">shipping</a> up sharply. 
 This brings us to a more important source of forecasting error: not taking our economic models seriously enough. Forecasts based on extrapolation from the recent past are nearly always as good as, or better than, those based on more sophisticated modeling. The exception is when there are economic inputs that are well outside the realm of recent experience. For example, the extraordinary $2.5 trillion in fiscal support for the US economy in 2021, amounting to 11% of GDP, was far larger than any previous fiscal package since World War II. 
 A simple fiscal multiplier model would have predicted that average output in the last three quarters of 2021 would be 2-5% above pre-pandemic estimates of potential. To think that a stimulus of this magnitude would not cause inflation required believing either that such a huge adjustment was possible within a matter of months, or that fiscal policy is ineffective and does not increase aggregate demand. Both views are implausible. 
 Economic models also gave us substantial reason to believe that several factors would reduce the US economy’s potential in 2021. These included premature deaths, reduced immigration, foregone capital investment, the costs of hardening the economy to COVID-19, pandemic-induced exits from the workforce, and all of the difficulties of rapidly reassembling an economy that had been torn apart. Such constraints made it very likely that additional demand would push inflation even higher. 
 A final set of errors arose because our models were missing key inputs or interpretations. To the degree that people relied on economic models, they often used a Phillips curve to predict inflation or changes in inflation based on the unemployment rate. But these frameworks had difficulty reckoning with the fact that the natural rate of unemployment likely rose, at least temporarily, as a result of the COVID-19 crisis. 
 More important, unemployment is not the only way to measure economic slack. Estimates from before the pandemic <a href="https://www.piie.com/blogs/realtime-economic-issues-watch/what-best-measure-labor-market-tightness" target="_blank" rel="noopener">show</a> that the “quit rate” and the ratio of unemployed workers to job openings are better predictors of wage and price inflation. These other indicators of slack were already tight at the beginning of 2021 and were very tight by the spring. 
 In retrospect, the mental model I find most useful for thinking about 2021 is to apply fiscal multipliers to nominal GDP, use them to predict how much of the fiscal stimulus will be spent, and then try to predict real GDP by understanding what the economy’s productive capacity is. The difference between the two is inflation. 
 Multipliers indicated that total spending in 2021 would go up a lot, while production constraints suggested that output would not increase by as much. The difference was unexpectedly higher inflation. 
 Where does this leave us in understanding inflation in 2022? Instead of making inertial forecasts that the future will resemble the past, taking our models seriously means accounting for high levels of demand, continued supply constraints, and ever tighter labor markets with rapidly rising nominal wages and higher inflation expectations. Some types of inflation, notably in goods prices, are likely to decline this year, but others, including services inflation, will likely increase. 
 I therefore expect another year of significant US inflation, maybe not as high as in 2021 but plausibly in the 3-4% range. But the most important forecasting lesson from last year is humility. We should all be adding some large error bands around our expectations and be prepared to update our outlooks as the economic situation unfolds. JASON FURMAN 
 Jason Furman, Professor of the Practice of Economic Policy at the Harvard Kennedy School and Senior Fellow at the Peterson Institute for International Economics, is a former chair of President Barack Obama’s Council of Economic Advisers.

Forecasting inflation is a staple of macroeconomic modeling, yet virtually all economists’ predictions for the United States in 2021 were way off the mark.

Why Did Almost Nobody See Inflation Coming?

As the world attempts to figure out how to live with COVID-19, it must also commit to identifying the missteps – accidental and otherwise – that caused the pandemic. That means, first and foremost, turning a critical eye toward China.

NEW DELHI – As the pandemic enters its third year, questions about COVID-19’s origins appear increasingly distant. But if we are to forestall another coronavirus pandemic in the twenty-first century, understanding the causes of the current one is imperative. 
 Already, COVID-19 has caused more than <a href="https://coronavirus.jhu.edu/map.html" target="_blank" rel="noopener">5.4 million deaths</a>. But that is just the beginning: the toll of the pandemic includes increased rates of <a href="https://www.cdc.gov/mmwr/volumes/70/wr/mm7037a3.htm" target="_blank" rel="noopener">obesity</a>, <a href="https://sgp.fas.org/crs/misc/R46554.pdf" target="_blank" rel="noopener">unemployment</a>, <a href="https://blogs.worldbank.org/opendata/updated-estimates-impact-covid-19-global-poverty-looking-back-2020-and-outlook-2021" target="_blank" rel="noopener">poverty</a>, <a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC8219297/" target="_blank" rel="noopener">depression</a>, <a href="https://www.medicalnewstoday.com/articles/depression-anxiety-spur-pandemic-alcohol-consumption" target="_blank" rel="noopener">alcoholism</a>, <a href="https://counciloncj.org/impact-report-1/" target="_blank" rel="noopener">homicide</a>, <a href="https://www.ucdavis.edu/curiosity/news/covid-19-isolation-linked-increased-domestic-violence-researchers-suggest" target="_blank" rel="noopener">domestic violence</a>, <a href="https://www.lexology.com/library/detail.aspx?g=9042d164-81ff-44b8-870a-ab3cf08d5793" target="_blank" rel="noopener">divorce</a>, and <a href="https://www.hopkinsguides.com/hopkins/view/Johns_Hopkins_Psychiatry_Guide/787393/all/Suicide_Risk_in_the_COVID_19_Pandemic" target="_blank" rel="noopener">suicide</a>. And, as the Omicron variant fuels record infection rates and disrupts economies in many parts of the world, pandemic fatigue is morphing into pandemic burnout. 
 Our chances of eliminating COVID-19 now appear increasingly remote. But, as we attempt to figure out <a href="https://www.wsj.com/articles/biden-in-shift-prepares-americans-to-see-covid-19-as-part-of-life-11641465004?mod=hp_lead_pos2" target="_blank" rel="noopener">how to live with the virus</a>, we must also identify the missteps – accidental and otherwise – that led us here. And that means, first and foremost, turning a critical eye toward China. 
 It is well known that Chinese President Xi Jinping’s regime <a href="https://www.nytimes.com/2020/12/19/technology/china-coronavirus-censorship.html" target="_blank" rel="noopener">censored early reports</a> that a new, deadly coronavirus had emerged in Wuhan and <a href="https://thehill.com/opinion/international/496081-if-there-was-no-coverup-why-is-china-opposing-an-inquiry?rl=1" target="_blank" rel="noopener">hid evidence</a> of human-to-human transmission, thereby enabling a local outbreak to become a global calamity. What remains to be determined is whether COVID-19 emerged naturally in wildlife or was leaked from a lab – namely, the Wuhan Institute of Virology (WIV). 
 Here, too, China has embraced obfuscation rather than transparency. Xi’s regime has blocked an independent forensic inquiry into COVID-19’s origins, arguing that any such investigation amounts to “<a href="https://www.mfa.gov.cn/ce/cgsy/eng/gdxw/t1896374.htm" target="_blank" rel="noopener">origin-tracing terrorism</a>.” After Australia called for a probe into China’s handling of the outbreak, Xi’s government punished it with a raft of <a href="https://www.cnbc.com/2020/12/18/australia-china-trade-disputes-in-2020.html" target="_blank" rel="noopener">informal sanctions</a>. 
 China had help covering up its bad behavior. Early in the pandemic, World Health Organization Director-General <a href="https://www.project-syndicate.org/columnist/tedros-adhanom-ghebreyesus" target="_blank" rel="noopener">Tedros Adhanom Ghebreyesus</a> parroted the Chinese government’s talking points and <a href="https://www.project-syndicate.org/commentary/world-health-organization-supports-china-covid19-narrative-by-brahma-chellaney-2020-04" target="_blank" rel="noopener">praised</a> its handling of the outbreak. Instead of verifying China’s claims, the WHO broadcast them to the world. 
 Yet far from condemning this failure of global health leadership, France and Germany took the lead in <a href="https://thehill.com/policy/healthcare/573800-france-germany-nominate-who-chief-for-second-term" target="_blank" rel="noopener">nominating</a> Tedros for a second term at the WHO’s helm, and the United States decided <a href="https://www.wsj.com/articles/who-chief-tedros-unopposed-in-bid-for-second-term-amid-covid-19-pandemic-11635532757" target="_blank" rel="noopener">not to field</a> a candidate to challenge him. Having run unopposed, Tedros will now lead this critical institution for another five years. 
 The West also helped China to divert attention from the lab-leak hypothesis. Not only are several labs in the West engaged in research to engineer super-viruses; Western governments have ties to the WIV – a French-designed institute where US-funded research has been carried out. Both the <a href="https://www.ncbi.nlm.nih.gov/search/research-news/9563/" target="_blank" rel="noopener">National Institutes of Health</a> and <a href="https://reschenthaler.house.gov/sites/reschenthaler.house.gov/files/Rep.%20Reschenthaler%20EcoHealth%20RESPONSE.pdf" target="_blank" rel="noopener">USAID</a> have <a href="https://www.nytimes.com/2021/10/21/science/bats-covid-lab-leak-nih.html" target="_blank" rel="noopener">issued grants</a> to EcoHealth Alliance, a group studying bat coronaviruses in collaboration with WIV researchers. 
 The US government has not disclosed the full extent of its funding to WIV projects, let alone explained why its agencies would fund research at an institution linked to the Chinese military. A January 2021 State Department <a href="https://2017-2021.state.gov/fact-sheet-activity-at-the-wuhan-institute-of-virology/index.html" target="_blank" rel="noopener">fact sheet</a> proclaimed that the US has “a right and obligation to determine whether any of our research funding was diverted to secret Chinese military projects at the WIV.” But why was that risk deemed acceptable in the first place? 
 The conflicts of interest surrounding the lab-leak hypothesis distorted early discussions about the origins of COVID-19. A <a href="https://thebulletin.org/2021/05/the-origin-of-covid-did-people-or-nature-open-pandoras-box-at-wuhan/" target="_blank" rel="noopener">letter</a> published in the Lancet in February 2020, signed by a group of virologists, is a case in point. The letter “strongly condemned” those “suggesting that COVID-19 did not have a natural origin.” The message was clear: to lend any credence to the possibility of a lab leak would be unscientific. 
 The letter turned out to be organized and drafted by the president of EcoHealth Alliance. But by the time the conflicts of interest came to light, it was too late. Major US news organizations and social-media giants were <a href="https://asia.nikkei.com/Opinion/China-must-come-clean-on-the-origins-of-COVID-19" target="_blank" rel="noopener">treating</a> the lab-leak hypothesis as a baseless conspiracy theory, with Facebook, Instagram, and Twitter censoring references to a lab accident. 
 It should always have been clear that the lab-leak hypothesis had merit: the 2004 outbreak of SARS (severe acute respiratory syndrome) in Beijing <a href="https://2017-2021.state.gov/fact-sheet-activity-at-the-wuhan-institute-of-virology/index.html" target="_blank" rel="noopener">resulted</a> from such a leak. Instead, frank discussion of the possibility was suppressed until May 2021, when US President Joe Biden <a href="https://www.whitehouse.gov/briefing-room/statements-releases/2021/05/26/statement-by-president-joe-biden-on-the-investigation-into-the-origins-of-covid-19/" target="_blank" rel="noopener">announced</a> that a lab accident was one of “two likely scenarios” on which US intelligence agencies would focus, as they carried out a 90-day inquiry into the pandemic’s origins. 
 By then, however, Chinese authorities had had plenty of time to cover whatever tracks there may have been. Add to that its unwillingness to cooperate in a probe, and it <a href="https://www.project-syndicate.org/commentary/china-obstructs-investigation-into-covid19-origins-by-brahma-chellaney-2021-08" target="_blank" rel="noopener">should not be surprising</a> that the inquiry’s results were inconclusive. 
 But the exercise was apparently enough to convince Biden to take the pressure off China. Despite <a href="https://www.whitehouse.gov/briefing-room/statements-releases/2021/08/27/statement-by-president-joe-biden-on-the-investigation-into-the-origins-of-covid-%e2%81%a019/" target="_blank" rel="noopener">pledging</a> to “do everything [possible] to trace the roots of this outbreak that has caused so much pain and death around the world,” he did not extend the intelligence inquiry, and he has since avoided any reference to the pandemic’s origins. 
 Xi <a href="https://www.scmp.com/news/china/science/article/3150777/xi-jinping-warns-chinese-laboratories-handling-deadly-pathogens" target="_blank" rel="noopener">announced</a> last September that Chinese labs handling deadly pathogens would face closer scrutiny, but he continues to denounce any insinuation that the coronavirus could have been leaked. Meanwhile, China is profiting from the pandemic; exports are <a href="https://www.wsj.com/articles/covid-19-sets-back-chinas-plans-to-rebalance-its-economy-11635084000" target="_blank" rel="noopener">surging</a>. The country has capitalized on the crisis to <a href="https://www.csis.org/analysis/china-exploiting-pandemic-advance-its-interests-mixed-results" target="_blank" rel="noopener">advance its geopolitical interests</a>, including by stepping up its territorial aggression, from East Asia to the Himalayas. 
 But a reckoning may yet come. Nearly three-quarters of Americans now <a href="https://www.reaganfoundation.org/media/358084/rndf_survey_booklet.pdf" target="_blank" rel="noopener">believe</a> that it is “likely” that COVID-19 was leaked from the WIV. Moreover, as China’s neo-imperialist ambitions have become clear, unfavorable views of China have <a href="https://www.pewresearch.org/global/2021/06/30/large-majorities-say-china-does-not-respect-the-personal-freedoms-of-its-people/?utm_source=AdaptiveMailer&amp;utm_medium=email&amp;utm_campaign=21-06-30%20Global%20Views%20of%20China%20GEN%20DISTR&amp;org=982&amp;lvl=100&amp;ite=8786&amp;lea=1875528&amp;ctr=0&amp;par=1&amp;trk=" target="_blank" rel="noopener">reached record highs</a> in many advanced economies. If world leaders wanted a mandate to pursue further inquiries into the pandemic’s origins, it is safe to say they have it. 
 This is not the first <a href="https://www.project-syndicate.org/commentary/china-exploit-control-of-pharmaceutical-exports-by-brahma-chellaney-2020-03" target="_blank" rel="noopener">made-in-China pandemic</a> – the country also produced <a href="https://www.nytimes.com/2004/07/21/world/china-releases-the-sars-whistle-blower.html" target="_blank" rel="noopener">SARS</a> in 2003, the <a href="https://pubmed.ncbi.nlm.nih.gov/30180422/" target="_blank" rel="noopener">Asian flu</a> in 1957, the Hong Kong flu in 1968, and the Russian flu in 1977. If the world keeps letting China off the hook, it will not be the last.

Here, too, China has embraced obfuscation rather than transparency. Xi’s regime has blocked an independent forensic inquiry into COVID-19’s origins, arguing that any such investigation amounts to “origin-tracing terrorism.”

The Great COVID Coverup

Turkish President Recep Tayyip Erdoğan insists that the country’s runaway inflation can be controlled by decreasing the nominal interest rate. But, given Turkey’s current strategy for financing growth, there are clear reasons why eschewing economic orthodoxy will only wreak further havoc with prices.

WASHINGTON, DC – Monetary policy in most economies today is anchored by an explicit inflation target, because targeting price stability has served both developed countries and emerging markets well. Until pandemic-related disruptions to supply chains and labor markets began fueling rapid price growth, inflation was well below target in major economies, and, sooner or later, the question of what to do in such situations will return. 
 The twentieth-century American economist Irving Fisher had an answer. Economic orthodoxy dictates that central bankers should increase nominal interest rates when inflation exceeds policymakers’ target. After all, raising interest rates reduces borrowing and spending, cooling the economy and curbing inflation. 
 Fisher, however, argued that when inflation is too low, central banks should raise their targets for nominal interest rates. He <a href="http://www.businessandeconomics.mq.edu.au/__data/assets/pdf_file/0017/220643/6-2002Cooray.PDF" target="_blank" rel="noopener">maintained</a> that there is a positive correlation between nominal interest rates and inflation. This relationship, known as the Fisher effect, can be seen in economic data. Modern macroeconomists interpret the causality as going from inflation to nominal interest rates. 
 Turkey is the first country to put Fisher’s theory to the test – but with a crucial twist. Turkish officials believe that high interest rates cause inflation, so they claim that there is causation in the other direction. Lowering interest rates, the <a href="https://www.ft.com/content/e15f8e00-b734-11e8-bbc3-ccd7de085ffe" target="_blank" rel="noopener">Turkish authorities say</a>, should reduce inflation. After all, as Fisher argued, the nominal interest rate is the sum of the real interest rate and future inflation. If the real interest rate is constant, then the only long-term effect of decreasing the nominal interest rate will be lower inflation because any effect on the real interest rate from lowering the nominal interest rate will disappear in the long run. 
 But in the short run, such monetary neutrality is absent, so a drop in the nominal interest rate also decreases the real interest rate. And that hurts both domestic and foreign savers, which is a major problem for a country like Turkey, which runs a persistent current-account deficit to finance its economic growth. 
 With the real interest rate currently negative, the neo-Fisherian experiment will make Turkey’s inflation problem worse. A country that needs both domestic and foreign savings to finance rapid growth cannot offer those savers negative returns. 
 To encourage continued domestic saving, the government recently announced a new policy: If the lira’s decline against major currencies exceeds banks’ short-term deposit interest rates, the government will pay holders of lira deposits the difference. For example, if banks pay 15% on 12-month lira deposits, and the lira depreciates 20% during this period, the treasury will make depositors whole. 
 While this policy might protect domestic savers and prevent them from abandoning the lira, it does nothing to encourage foreign savers. The resulting outflow of foreign capital will accelerate lira depreciation and fuel further inflation. And, because the policy puts the entire currency risk on the government, it will weaken public finances and eventually could lead to debt monetization. 
 Why would the government put in place a costlier alternative to a tighter monetary policy? The answer is straightforward: Turkey’s short-run growth model runs on credit, which requires that domestic borrowers be able to borrow at low interest rates. 
 But the role of foreign capital flows in those domestic lending rates betrays the model’s fatal flaw. If a country has external financing needs and funds its growth with foreign savings, capital flows are a more important determinant of short-term domestic lending rates than the monetary policy rate – <a href="https://www.kansascityfed.org/documents/6951/Ozcan_JH2019.pdf" target="_blank" rel="noopener">a phenomenon known as the “short rate disconnect</a>.” This is because domestic banks depend on international financial markets to fund themselves. 
 For foreigners who lend to these banks, there should not be any difference between lira deposit rates and dollar deposit rates once they are adjusted for expected depreciation. This is not true in the Turkish case. 
 If foreign institutions lend in lira, they charge a risk premium, which now has increased, owing to massive exchange-rate depreciation. And if they lend in dollars, they charge a premium for default risk, which also has grown. The recent record-high <a href="https://www.bloomberg.com/news/articles/2021-12-22/turkey-debt-risk-near-pandemic-peak-signals-doubt-over-lira-plan" target="_blank" rel="noopener">Turkish credit-default swap spreads</a> are a good example of this. As foreign investors abandon Turkish markets – or charge higher risk premiums to stay – both currency depreciation and inflation will increase. 
 To defend the lira and revive capital inflows, inflation targeting must be done right. If inflation exceeds the official target, then policy rates should be increased to cool the economy and stabilize prices. A small, open economy that finances its growth with foreign savings cannot fight inflation and stem currency depreciation without a credible monetary policy. A Neo-Fisherian approach is no substitute.

Until pandemic-related disruptions to supply chains and labor markets began fueling rapid price growth, inflation was well below target in major economies, and, sooner or later, the question of what to do in such situations will return.

Turkey’s Risky Inflation Experiment

NEW YORK – My book, <a href="https://www.penguinrandomhouse.com/books/534994/a-world-in-disarray-by-richard-haass/" target="_blank" rel="noopener">A World in Disarray</a>, was published five years ago this month. The book’s thesis was that the Cold War’s end did not usher in an era of greater stability, security, and peace, as many expected. Instead, what emerged was a world in which conflict was much more prevalent than cooperation. 
 Some criticized the book at the time as being unduly negative and pessimistic. In retrospect, the book could have been criticized for its relative optimism. The world is a messier place than it was five years ago – and most trends are heading in the wrong direction. 
 At the global level, the gap between challenges and responses is large and growing. The COVID-19 pandemic exposed the inadequacies of international health machinery. We are entering the third year of the pandemic, but still do not know its origins, thanks to Chinese stonewalling. 
 What we do know is that more than five million people, and more likely 15 million, have died. We also know that some <a href="https://ourworldindata.org/covid-vaccinations?country=OWID_WRL" target="_blank" rel="noopener">three billion people</a> (many in Africa) have yet to receive a single dose of a COVID-19 vaccine. And we know that the ongoing pandemic has <a href="https://www.imf.org/en/Publications/WEO/Issues/2021/10/12/world-economic-outlook-october-2021" target="_blank" rel="noopener">reduced global economic output</a> by trillions of dollars. 
 Climate change has advanced. The world is already more than 1° Celsius warmer than it was at the start of the industrial revolution and is on course to get warmer. Extreme weather events are more frequent. Fossil fuel use is up. 
 Governments have pledged to do better. Their performance remains to be seen; in some cases, including China and India, the world’s two most populous countries, the pledges are noteworthy for their lack of ambition and urgency. 
 Cyberspace remains akin to the Wild West, with no sheriff willing or able to set boundaries on acceptable behavior. There is not even the pretense of global cooperation. Rather, we see technology outpacing diplomacy, with authoritarian governments going to considerable lengths to wall off their societies while violating the cyberspace of others to sow political discord or steal technology. 
 Nuclear proliferation continues. North Korea has increased the quantity and quality of its nuclear arsenal and the range and accuracy of its missiles. And, in the aftermath of the unilateral US decision in 2018 to exit the accord that placed temporary ceilings on Iran’s nuclear capabilities, the Islamic Republic has gone from being a year away from possessing a nuclear weapon to just a few months or even weeks. 
 Great power rivalry is more pronounced than at any time since the Cold War. US-China relations have deteriorated rapidly, mostly owing to increased Chinese repression at home, trade and economic frictions, and China’s growing military strength and increasingly assertive foreign policy. Against a backdrop of growing economic competition and possible conflict over Taiwan, it is unclear whether the two countries will be able to cooperate on global challenges like public health and climate change. 
 Russia is arguably even more disaffected with the world order. Three decades after the end of the Cold War, President Vladimir Putin, seemingly ensconced in power for the foreseeable future, is set on stopping or, if possible, reversing NATO’s reach. Putin has shown himself to be comfortable using military force, energy supplies, and cyberattacks to destabilize countries and governments he views as adversarial. The immediate target is Ukraine, but the strategic challenge posed by Putin’s Russia is much broader. 
 Other developments also offer reason for concern. More than 80 million – one in every hundred people – are displaced. <a href="https://www.rescue.org/sites/default/files/document/6423/ircwatchlist2022reportfinal.pdf" target="_blank" rel="noopener">Many times that number</a> are enduring what can only be described as a humanitarian crisis. The Middle East is home to several ongoing wars that are simultaneously civil and regional. 
 Democracy is in <a href="https://freedomhouse.org/report/freedom-world/2021/democracy-under-siege" target="_blank" rel="noopener">retreat</a> in much of the world, not just in dramatic cases such as Myanmar and Sudan, but also in parts of Latin America and even Europe. Haiti and Venezuela are essentially failed states, as are Libya, Syria, and Yemen. Afghanistan appears on its way to again becoming a world leader in terrorism, opium production, and misery. 
 There is one other critical factor: The United States is in greater disarray internally than it was five years ago. Political polarization is at an all-time high, and political violence has emerged as a serious threat. The peaceful transfer of political power following elections can no longer be taken for granted. This internal reality has in turn accelerated America’s pullback from global leadership after three-quarters of a century. No other country is able and willing to assume this role. 
 To be sure, some positive developments deserve mention: the rapid creation of vaccines that dramatically reduce vulnerability to COVID-19; new green technologies that reduce reliance on fossil fuels; growing cooperation between the US and several of its partners to push back against a more forceful China; and the simple fact that, so far, great power rivalry has not descended into war. 
 What would it take to avoid a future defined by disarray? A short list would include widespread vaccination against COVID-19 and new vaccines effective against future variants; a technological or diplomatic breakthrough that would dramatically reduce the use of fossil fuels and slow climate change; a political settlement in Ukraine that promotes European security and an outcome with Iran that prevents its becoming a nuclear or even near-nuclear power; a US-China relationship able to put in place guardrails to manage competition and avoid conflict; and a US that managed to repair its democracy sufficiently so that it had the capacity to focus on world events. 
 As always, little is inevitable, for better or for worse. What is clear, though, is that trends will not improve by themselves. Innovation, diplomacy, and collective will are needed to turn things around. Unfortunately, the last two are in short supply.

At the global level, the gap between challenges and responses is large and growing. The COVID-19 pandemic exposed the inadequacies of international health machinery. We are entering the third year of the pandemic, but still do not know its origins, thanks to Chinese stonewalling.

A World of Mounting Disarray

While the conventional wisdom is that the next financial crash will come from the collapse of the cryptocurrency bubble, climate finance may pose a more serious risk. Mounting evidence suggests that green lending is displaying all the pathologies associated with financial manias.

PROVIDENCE – In the last few years, and especially after the recent United Nations Climate Change Conference (COP26) in Glasgow, private investors have seen an opportunity to midwife developing countries’ bumpy transition to net-zero carbon-dioxide emissions. After all, if BlackRock CEO Larry Fink and the climate activist Greta Thunberg can find <a href="https://www.forbes.com/sites/hershshefrin/2020/02/02/blackrock-and-greta-thunberg-team-up-well-sort-of/?sh=2e9d3a37554c" target="_blank" rel="noopener">common cause</a>, then the tantalizing prospect held out by William Blake – “Great things are done when men and mountains meet” – comes into view. 
 The heady optimism is reflected in the numbers. Asset managers think that <a href="https://www.ft.com/content/89fbcd50-8eac-4092-a24d-ae863c051058" target="_blank" rel="noopener">tens of trillions of dollars</a>, mostly in the form of green finance, could be available for environmental, social, and governance (ESG) lending. Former Bank of England governor Mark Carney claims to have <a href="https://www.bloomberg.com/news/articles/2021-11-02/carney-s-climate-alliance-crests-130-trillion-as-pledges-soar" target="_blank" rel="noopener">mobilized $130 trillion</a> to help finance the net-zero transition. The $100 billion per year in climate finance that rich countries promised to provide to the developing world at COP15 in 2009 – a pledge that remains unfulfilled – is starting to look like chump change by comparison. 
 Developing economies’ response to the new push for net-zero emissions has rightly focused on rich countries’ <a href="https://www.project-syndicate.org/commentary/climate-change-cop26-rich-world-hypocrisy-by-jayati-ghosh-2021-11?barrier=accesspaylog" target="_blank" rel="noopener">fossil-fuel hypocrisy</a>. As Vijaya Ramachandran of the Breakthrough Institute and Todd Moss of the Energy for Growth Hub have <a href="https://foreignpolicy.com/2021/12/06/africa-climate-emissions-energy-renewable-gas-oil-coal/" target="_blank" rel="noopener">noted</a>, advanced economies are asking developing countries to phase out coal and natural gas while continuing to rely on the latter energy source in particular. The rich world’s failure to cough up the necessary finance just compounds the hypocrisy. 
 But developing countries’ fears are misplaced. Perhaps they should worry not that there will be too little climate finance, but rather that there will be too much, especially from the private sector. It’s not hard to see why. 
 An implicit bargain – finance in exchange for fossil-fuel reduction – underlies the current intellectual consensus on climate change: the rich provide the funding while the poor move to renewables. But whereas the onus a decade ago was on rich-country governments to mobilize the money, the expectation now is that the private sector will do so. 
 This bargain is problematic for two reasons: implicit political condescension and looming economic risks. 
 The condescension can be summed up starkly: “We, the rich, have messy politics, but the poor don’t.” For example, when protesters in France pushed back against increases in fuel taxes in 2018 and 2019, the discussion focused on the difficulty of climate action and the need to accept the rollback of those taxes as an understandable consequence of democratic politics. But such latitude ends where the Global South begins. There, finance is somehow a magic bullet that overcomes social and political obstacles to climate action. 
 The Indian government’s <a href="https://www.reuters.com/world/india/indias-modi-repeal-controversial-farm-laws-2021-11-19/" target="_blank" rel="noopener">recent retreat</a> on its planned reforms of the agricultural sector, following a successful 15-month protest by farmers, shows how misguided this view is. One concession that the farmers extracted from the government was to forestall any effort to reduce the large power subsidy they receive. The subsidy is devastatingly harmful in terms of CO2 emissions, soil quality, water availability, and atmospheric pollution. But reducing it will be fiendishly difficult, with or without external finance. 
 More important are the bargain’s economic risks. Climate change affords investors an opportunity to do global social good without sacrificing profits. And ESG-related lending, which marries conscience and capital, has become a major financial fad. 
 But mounting evidence suggests that this activity is displaying all the pathologies associated with financial manias and bubbles. Tariq Fancy, a former senior investment officer at BlackRock, <a href="https://www.cnbc.com/amp/2021/08/24/blackrocks-former-sustainable-investing-chief-says-esg-is-a-dangerous-placebo.html" target="_blank" rel="noopener">has spelled them out</a>. Opportunities for green projects in developing countries are over-hyped. Questionable ESG standards and ratings result in fuzziness about how to measure the ESG impact of funding, as well as doubts about borrowers’ incentives, given the relatively light and back-loaded nature of penalties for noncompliance. Because finance is fungible, some firms may obtain ESG financing only to divert other sources of funding to non-ESG activities. 
 If trillions of dollars in climate finance go to emerging markets, the flows could amount to 5-10% of these economies’ GDP – similar to the financing surges that preceded the 1997 Asian financial crisis and the 2013 “taper tantrum.” Unregulated private capital flows of this magnitude will lead to overheating, volatility, imprudent lending, and overvalued exchange rates. Eventually, when the mania is seen for what it is, costly consequences will follow: capital flows will reverse, and both output and the financial sector will collapse. We have seen this movie before in country after country, and we know how it ends: badly. 
 Turkey is only the latest example of financial globalization gone wrong, as Harvard’s Dani Rodrik and I have <a href="https://www.piie.com/commentary/speeches-papers/why-did-financial-globalization-disappoint" target="_blank" rel="noopener">argued</a>. Long periods of private financial inflows indulge rather than discipline unsustainable macroeconomic policies, until the inflows suddenly become outflows, as they invariably do. Of course, if interest rates start rising in advanced economies, capital will become more expensive for poorer countries. But insofar as there is enough liquidity still sloshing around in the system, the risks associated with large-scale ESG and climate financing are real. A cynical view is that private climate finance could end up damaging poorer economies and producing little by way of climate-positive outcomes, while enabling the financial sector to coat its somewhat tarnished reputation with a patina of green. The conventional wisdom is that the next financial crash will come from the collapse of the cryptocurrency bubble. But climate finance may pose a more serious risk. Financial markets are naturally wary toward cryptocurrencies and the like, owing to the realization that these are inherently risky assets (if they can be called assets at all), the type of investors they attract, and the whiff of Ponzi that hangs over them. In contrast, ESG investing appears more serious and less risky, and its halo of perceived social good could easily lull regulators into leniency and inattention. 
 As Mark Twain wisely warned, “It’s not what you don’t know that kills you; it’s what you know that ain’t so.” Private climate finance could be the next financial bubble – and the world needs to wake up to the danger.

 An implicit bargain – finance in exchange for fossil-fuel reduction – underlies the current intellectual consensus on climate change: the rich provide the funding while the poor move to renewables. 

Is Climate Finance the Next Bubble?

In recent decades, the US and Europe have consistently dismissed Russia’s security concerns relating to its former territories, and portrayed its resistance to NATO’s eastward expansion as paranoid revanchism. Until the West changes its approach, the cycle of crises will continue, with escalating risks.

MOSCOW – With thousands of Russian troops now massed near Ukraine’s border, the <a href="https://www.reuters.com/world/europe/russia-expects-security-talks-right-start-next-year-ifax-cites-formin-2021-12-22/" target="_blank" rel="noopener">announcement</a> that Russia and the United States will soon hold security talks is undoubtedly welcome. While a de-escalation of tensions is hardly guaranteed, it is a lot harder to talk past someone who is in the same room.

Peter Klaunzer/Pool/Keystone via Getty Images

The US wants to prevent anything like a repeat of the events of 2014 in Ukraine. This seems like the fair thing to do.

What the US Misunderstands About Russia

Although major economies and markets fared well in 2021 despite all of the uncertainties surrounding new variants of the coronavirus, 2022 will bring new challenges. In addition to central banks shifting toward policy normalization, geopolitical and systemic risks are multiplying.

NEW YORK – Despite dips and disruptions from new variants of COVID-19, 2021 turned out to be a relatively positive year for economies and markets in most parts of the world. Growth rose above its potential after the severe recession of 2020, and financial markets recovered robustly. This was especially the case in the United States, where stock markets reached new highs, owing partly to the US Federal Reserve’s ultra-loose monetary policy (though central banks in other advanced economies pursued radically accommodative policies of their own).

The pandemic is not over. Omicron may not be as virulent as previous variants – particularly in highly vaccinated advanced economies – but it is much more contagious, which means that hospitalizations and deaths will remain high. The resulting uncertainty and risk aversion will suppress demand and exacerbate supply-chain bottlenecks.

Clouds Over 2022

In a pandemic, you can send people all the money in the world and they still won’t go out to dinner or book a flight, especially if those services are suspended by government fiat. A pandemic is like a blizzard: If people get a lot of money when the snow is falling, they will fuel inflation once it has been cleared.

STANFORD – Inflation continues to surge. From its inflection point in February 2021 to last month, the US <a href="https://www.bls.gov/cpi/" target="_blank" rel="noopener">consumer price index</a> has grown 6% – an 8% annualized rate.

 Inflation continues to surge. From its inflection point in February 2021 to last month, the US consumer price index has grown 6% – an 8% annualized rate.

The Ghost of Christmas Inflation

Feelings are facts and facts define us. Under no circumstances try to define our identity, but make sure to use the correct pronouns when you do. Guest columnist Lovisa Tengberg brings much needed clarity to the complex issue of identity.

I always felt different. Instead of joining the Legally Blonde hair debate with suburban Ashley, I found myself eyeing another table across the lunch hall. Their carefully braided hair, their swag, their music, and their speech – so unpretentious. They grew up with single moms, their dads were in prison, and they knew the rough life. I felt exactly like them – I had just been born in the wrong skin.

”I felt, therefore I was. I was Tibetan. Finally, it all made sense.”. Painting: Heinrich Menu von Minutoli 

Our guest columnist Lovisa Tengberg brings much needed clarity to the complex issue of identity.

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