02 September 2020

Only Took 43 Years

The Federal Reserve has been required to place equal weight on full employment and prices stability since the passage of the Humphrey-Hawkins act in the late 1970s.
It hasn't. Instead, it has gone for real unemployment while fighting imaginary inflation.

It only took a few decades, but now the Fed has decided to change its policy, and so will no longer engage in monetary tightening just because unemployment is low, they will wait for actual inflation to show up:
In a historic break with decades of policy, the Federal Reserve announced Thursday that it will no longer deliberately keep millions of Americans unemployed at all times.

America’s central bank has a dual mandate — to promote full employment and price stability. These two aims were long presumed to be in tension: If unemployment fell too low — such that there was no slack in the labor market (i.e., no reserve of jobless workers for employers to draw on) — then workers would gain the upper hand on their bosses and demand wage gains in excess of their own productivity, which would force companies to raise the prices of their goods to keep up with their labor costs, which would then cause workers to demand still-higher wages to keep up with prices, in a vicious inflationary cycle.

For this reason, the Fed defined “full employment” as an unemployment rate significantly above the level one would expect from mere job-switching frictions. And when the labor market tightened beyond the level the Fed deemed conducive with price stability, it would start raising interest rates — to choke off credit creation, slow growth in the money supply, and thus, deliberately keep Americans out of work — even if inflation had not yet exceeded its official target.


In the aftermath of the Great Recession, the inequity of the central bank’s longtime prioritization of avoiding theoretical inflation — over the certain unemployment of millions of workers — became more conspicuous. The Fed’s official inflation target is 2 percent. But for a variety of reasons — among them, the tepid pace of the recovery and the weak bargaining power of American workers in an age of trade-union decline — price growth remained stubbornly below those levels, even as the central bank kept interest rates near zero. Nevertheless, despite the absence of any hint of excessive inflation, the Fed began raising interest rates in 2015, on the grounds that the U.S. could not sustain an official unemployment rate of below 5 percent without triggering a wage-price spiral.

Progressive (and a few growth-oriented conservative) economic-policy wonks pushed back on this move. Then, when a Republican president with a penchant for easy money came to power — and the GOP’s inflation hawks went dutifully silent — Trump’s appointed Fed chair, Jerome Powell, adopted a more accommodative stance. And America proceeded to learn that its economy could not only abide a 3.6 percent unemployment rate without suffering runaway inflation, but that such a rate wasn’t even sufficient to bring inflation to its target level of 2 percent. The theorized hard trade-off between unemployment and price stability did not appear to exist, which meant that America’s finest economic minds had been slowing growth and killing jobs for no good reason.


(1) The Fed will no longer presume that it knows what the maximum level of employment in the U.S. economy is, and will therefore refrain from raising interest rates until there are clear signs of excessive inflation.

(2) The Fed will not treat its 2 percent inflation target as a maximum, but rather as the average rate it wishes to promote over an extended period of time. Which is to say: If inflation runs a bit below that target for years on end, then the Fed will tolerate inflation a bit above that target for a few years after.
I am not surprised that the Fed Chair who did this is not an economist.


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