Since Jerome Powell has been Federal Reserve chairman, especially as his term renewal approached earlier this year, the central bank and its members have, with great frequency, referred to their “dual mandate.”
That is not a coincidence. The Fed is under pressure by progressives to run the most accommodative policy possible.
Progressives who had their policy goals stifled in the Senate have sought an alternate way to reach their objectives. Barack Obama, and Donald Trump after him, relied on executive orders. But those can only go so far and are just as easily overturned by the next president.
Democrats have spread their wings to try to use existing institutions to pursue policy objectives outside their normal remit. They have found a way to pursue goals they have not been able to achieve through legislative channels. Saddling the Fed with the responsibility of solving the unemployment problem among minorities and address climate change are two examples.
Joe Biden first sought Saule Omarova as comptroller of the currency. But this position required confirmation and Republicans reacted adversely to the Cornell law professor’s nomination; she was also a graduate of Moscow State University and she opposed lending to oil companies, a “green” objective of the president and a number of members of his party. Eventually this nomination was quashed. For now, there is an “acting” comptroller.
The Fed, on the other hand, has been pliable in the face of pressure since it was created by an act of Congress and is more subject to direct congressional prodding. The Fed has been “convinced” to put climate-change provisions in its lending assessments as well as to bend its macro policy in a way progressives think will help to employ minorities by delaying interest-rate hikes. That tact is fool’s gold, as we are now seeing.
The Fed’s true job
Giving the Fed a spurious new policy mandate is not a good idea since there is no logical connection between these new mandates, Fed monetary policy, prudential risk or even credit risk except in the most extraneous way. Arguably, giving the Fed these new mandates helped to distract it from its true job and helped inflation to gain purchase and get out of control.
Whatever the reason, the Fed should not be enlisted to spearhead social policy goals. The view by progressives is that the Fed has a dual mandate and that it should seek full employment in the short run. That appears to be the new interpretation. This, in fact, is a damaging point of view. The Fed has never done that with success. Monetary policy is better focused on the long term.
The Fed’s minutes from its last meeting have just been announced and a thorough reading leads to the inescapable conclusion that the Fed is unwilling to say that it is determined to raise interest rates to reduce the inflation rate even if it results in higher unemployment. The Fed, in its minutes, instead gives credence to both objectives and pledges allegiance to both. Therefore, we’re unable to tell what happens if “push comes to shove” and the Fed must choose between them.
The starkest example of the Fed being hog-tied on this choice is simply to notice that with inflation at a 40-year high and unemployment near a 50-year low (and only briefly lower for a short time under Donald Trump), the central bank is unwilling to clearly prioritize reducing inflation.
To be sure, the minutes showed that the Fed talked of reducing inflation and expressed its determination to do so. But it also expressed its commitment to low unemployment. Of course, the Fed never explicitly says “yes, but” — yet that omission hangs in the air.
In a telling passage on participants’ views, the minutes say, without the slightest sense of urgency:
“Participants agreed that the economic outlook was highly uncertain and that policy decisions should be data dependent and focused on returning inflation to the Committee’s 2 percent goal while sustaining strong labor market conditions.”
The Fed still seems to believe that the unique market circumstance that prevailed before Covid struck are still in operation. In the new millennium, technology advanced, cell-phone use spread, the internet was used to check prices, international trade grew, a globally competitive situation deepened and companies’ determination to hold the line on pricing led to an extended period of continued low inflation.
Companies discovered that raising prices cost them business. So, a pressure-cooker model emerged in which prices were contained and used to cook a better product. Either productivity went up, workers were let go, business was farmed out and globalized, or suppliers were made to cut input costs. The line on prices held. As long as companies didn’t raise prices, they didn’t easily raise wages. There was no wage-price spiral; the Phillips Curve deflated; a golden era of price stability emerged.
Still, from 2015 to 2018, the Fed denied it and continued to fear upstart inflation, hiking rates assiduously during part of those years to contain nonexistent inflationary forces. That is something for which progressives berated the Fed, leading to the Fed’s new permissive behavior. As a result, the Fed got religion and suddenly recognized the changed anti-inflationary environment — just as it was being undercut by events. Covid and its aftermath have destroyed whatever special environment used to exist. The Fed did not see it and instead became less vigilant on inflation and more willing to pursue progressives’ objectives as fiscal policy excess bloated the budget.
The Fed models did not see inflation coming, but one economist, Larry Summers, a Democrat, saw fiscal stimulus far larger than the GDP-gap on offer and called out his warning only to be drowned out again by progressive voices. This is where inflation came from.
And, now, with inflation beating down the door, the Fed still can’t see the error of its ways. It can only feel the political pressure at its door. That is reason enough to worry how strongly the Fed will act to eliminate inflation and to wonder if too-high inflation will remain an ugly fact of life for years to come. Fiscal policy may have started it, but monetary policy nurtured it, and now monetary policy alone will have to stop it.
Robert Brusca is chief economist of FAO Economics.