The new policy “virtually guaranteed that the Fed would be behind the inflation curve,” Sen said. Pat Toomey (Pennsylvania), the top Republican on the Senate Banking Committee. “It’s time for a new frame.”
It’s the latest chapter in a long-running, often partisan struggle between those who think the Fed should focus more on preventing inflation by controlling spending and wages, and those who think a some inflation is a valid trade-off for booming work. market. At stake is the momentum gained by many on the left, who have successfully argued that the Fed overestimated the danger of inflation in the wake of the 2008 financial crisis.
Progressive economists, labor advocates and other Fed watchers are fiercely defending the merits of the Fed’s jobs-promoting approach and warning of serious consequences for disadvantaged Americans if the central bank is reverting to its old ways of preventing unemployment from falling below a certain threshold and crimping growth too soon.
“Because we had a much faster recovery than in previous downturns, the scars for workers have been less,” said William Spriggs, a Howard University professor and chief economist at the AFL-CIO. The percentage of black workers who were employed “did not accelerate until the end of 2021”, he pointed out.
The Fed’s new policy was born out of the lessons of the Great Recession. Former Fed Chair Janet Yellen allowed rates to stay low for years after the recession to boost jobs, despite dire warnings from many economists and congressional Republicans that she would foment runaway inflation. That inflation never happened, and the data suggests the Fed could have been even more cautious, with inflation still subdued and wages rising only modestly when it started raising rates.
Against this backdrop, activist groups like the Fed Up campaign have lambasted the central bank for holding back job creation for workers.
Eventually, Fed Chairman Jerome Powell, a Republican raised to head the central bank by former President Donald Trump, admitted the Fed could have been softer in raising borrowing costs. Prominent Democrats like Sens. Sherrod Brown (D-Ohio) and Elizabeth Warren (D-Mass.) urged the Fed to work to close racial employment gaps.
In August 2020, the Fed put the finishing touches on its new policy stance, where it would allow inflation to rise a bit more before tightening and pursuing “broad and inclusive” employment.
But the policy was designed for an economy that doesn’t look like the pandemic-era world. When unemployment was 3.5% before the pandemic, inflation was still below its target of 2% – a target chosen because the Fed believed it would keep interest rates low enough to make way for inflation. growth but high enough that prices do not rise unsustainably.
The policy was meant to manifest a world in which inflation rose based on sound economic factors – plentiful jobs, supported by economic growth, which drive up wages as well as prices.
These days, the central bank doesn’t talk much about its hailed approach.
“The framework was meant to address a certain problem,” said Bill Nelson, chief economist at the Bank Policy Institute and a former top Fed official. “Now that interest rates are above zero, that’s not really relevant anymore.”
Senior Fed officials have publicly acknowledged that the central bank probably should have acted sooner to start curbing soaring prices, which have risen more than 8% over the past year. This was largely because he saw inflation as being caused by supply problems in key sectors, which he expected to start easing much sooner.
But the central bank delayed raising interest rates even as it grew more wary that price spikes had begun to spread across the economy in October and November, citing the focus put on the return of previously employed workers who had left the workforce during Covid. But inflation continued to pick up and the Fed accelerated its timetable to start making borrowing more expensive.
“The inflation we got was not at all the inflation we were looking for or talking about,” Powell told reporters in December. “It had to do with, you know, strong monetary policy and fiscal stimulus in an economy that was recovering quickly and where there were these supply-side barriers.”
“And the way we approached it really has nothing to do with our [new] framework,” he added.
Since late last year, labor force participation has increased significantly, but not yet to pre-pandemic levels, and the unemployment rate has fallen to 3.6%, suggesting that the Fed has helped to further restore the labor market.
“They succeeded on the labor market side,” said Skanda Amarnath, executive director of labor advocacy group Employ America, adding, “The counterfactual in which the eruption of inflation was to be averted actually seems quite difficult to imagine.” He pointed to price spikes, for example, in Europe.
Still, Fed officials fear they may have exaggerated, with job offers outstripping available workers. Former New York Fed Chairman Bill Dudley said recently that he was never comfortable with the idea that the Fed would wait for the labor market to contribute to inflation before it even started. to raise rates.
This engagement “by definition was going to make them very late at some point,” he said at an event hosted by the Shadow Open Market Committee.
“If the Fed brings inflation back in a timely manner, all it’s doing is slowing spending growth,” said George Selgin, senior fellow at the Cato Institute. “That would not necessarily have prevented the level of employment from continuing to decline.”
And now, the longer-term benefit of the Fed’s initial patience is not guaranteed. Unemployment is low and vacancies are plentiful, giving low-income workers more freedom to change jobs and earn higher wages. But wages still haven’t kept pace with inflation, which many economists say means the labor market isn’t really a major factor in the price spike yet.
“There’s a disconnect between the micro and the macro,” said Nela Richardson, chief economist at payroll processing firm ADP. “The microphone says, ‘I don’t get paid enough. My wages are falling rapidly. The macro says: “you are overpaid and could possibly contribute to inflation”.
Now, workers could suffer collateral damage as the Fed continues to raise rates.
“Their position in January 2020 was that we can keep rates lower for longer without fueling inflation,” Richardson said. “Two years later, they are launching a campaign that will focus on destroying demand to reduce the very wage gains and the very communities they sought to help.”
“The Fed landscape has really changed,” she added. “Perhaps the next step for the Fed is a more agile framework.”