In many ways, new Federal Reserve Chairman Jerome Powell’s first testimony before Congress this week was like what we heard from Ben Bernanke and then Janet Yellen about the Fed’s support for its dual mandate from Congress to promote maximum employment and stable prices. But due to some specific words from Powell, commentators and markets think the Fed may now focus more on preventing inflation and, hence, raise interest rates more aggressively.
Throughout the recovery from the Great Recession, the Fed under Bernanke and Yellen was cautious about unwinding monetary stimulus — that is, measures like maintaining an historically low short-term interest rate target and buying lots of longer-term assets (quantitative easing) to accommodate strong job growth and rising employment. The Fed’s pursuit of maximum employment did not conflict with its other goal of stable prices since inflation remained below the Fed’s 2 percent target. In fact, the Fed’s persistent failure to reach its inflation target suggests it could have even more aggressively tried to speed up the labor market’s recovery.
Nonetheless, as Powell told a House committee on Tuesday, unemployment has fallen to 4.1 percent, about three quarters of a percentage point lower than a year ago and its lowest level since December 2000. Various other indicators of labor market health also continued to improve over the past year. Yet inflation remains below target. Contrasting the still-improving labor market health and the still-below-target inflation, Powell echoed Yellen’s previous statements. But here’s the twist, as documented by the Fed watcher and economist Tim Duy.
Political Cartoons on the Economy
As the economy approached full employment, the Fed began to gradually raise its target range for the federal funds rate, which was between zero and 0.25 percent from the end of 2008 all the way to the end of 2015 and which is now between 1.25 percent and 1.5 percent. As Duy points out, Yellen described the Fed’s policy last July as gradual increases “to achieve and maintain maximum employment and stable prices” and last November as gradual increases “to sustain a healthy labor market and stabilize inflation around the 2 percent objective.” Now, however, Powell is describing the appropriate path as one that will “strike a balance between avoiding an overheated economy and bringing price inflation to 2 percent.”
“Avoiding an overheated economy” isn’t just a different way of saying “sustaining a healthy labor market.” Very low unemployment brings substantial economic gains to traditionally disadvantaged groups of workers, especially African-Americans – who remain disadvantaged by racial inequality a half-century after the Kerner Commission documented the problem in 1968. “Maintaining a healthy labor market” connotes trying to achieve, solidify and maintain those gains. “Avoiding an overheated economy” connotes a willingness to risk those gains in order to avoid any possibility of higher inflation by preventing the economy from ever running too hot.
Yes, the likelihood of somewhat higher inflation rises with very low unemployment, but Powell’s language raises the concern that the Fed will view the 2 percent target as a ceiling, rather than its stated position that inflation should be 2 percent on average. The latter implies that inflation would sometimes rise above 2 percent in a particularly strong economy and sometimes drop below it in a weaker economy. Viewing 2 percent as a ceiling would mean that, on average, inflation would be lower than 2 percent and the economy and the labor market would, on average, be less healthy than they could be.
The change in emphasis is subtle. No one thought Powell was signaling that the Fed is preparing to slam on the monetary policy brakes. In companion testimony before a Senate committee on Thursday, he stated that there’s no evidence that the economy is currently overheating and that he expects the Fed’s current path of gradually raising interest rates to continue to be the appropriate one.
Starting with Bernanke, the Fed has tried to be much more publicly forthcoming about its intentions. That hasn’t always worked as intended. Let’s hope, however, that there’s more smoke than fire in Powell’s altered description of the Fed’s goals, and that the Fed won’t let inflation fears undermine the real economic gains that workers — especially the traditionally disadvantaged — can achieve if it sustains a healthy labor market.