Powell’s historic bet: ignoring inflation to create jobs

Powell, newly appointed by President Joe Biden for a second term, would disappoint many progressives and Fed watchers if he chose to curb the central bank’s efforts to stimulate the economy. But pressure will also intensify for the Fed to raise interest rates if price hikes continue.

“The big challenges facing the Fed chair are: determining the nature of this inflation and this moment in the economy – then implementing a plan in the face of many cries,” said Austan Goolsbee, a professor at the University of Chicago who was one of President Barack Obama’s main economic advisers.

Over the past week, some leading moderate Democrats have called on the Fed to step up efforts to scale back its massive bond-buying program, which aims to keep borrowing costs low, and to consider to raise rates faster than expected.

“The central bank should express a more realistic understanding of inflation and strengthen its monetary policy by reducing asset purchases more quickly,” wrote Jason Furman, a professor at Harvard and chairman of the Obama Council of Economic Advisers, in the Wall Street Journal. “They have a dual mandate. They must take inflation into account even if the economy is not yet at peak employment.

Steven Rattner, also a former Obama official, wrote that for the Fed, “Tackling inflation means raising interest rates, perhaps sooner than he deems necessary.”

But a senior White House official stressed the importance of the Fed’s commitment to return the economy to full employment, saying that position played a significant role in Biden’s decision to re-appoint Powell, although the administration emphasizes the political independence of the central bank.

“A year ago, forecasters said it would take us another two years to reach an unemployment rate of 4.6%,” the official said. “We are there, and it is thanks to the combined power of fiscal and monetary policy.”

The Fed’s willingness to be patient in the face of aggressive price hikes is a tangible shift from the usual central bank reaction in previous decades. Policymakers have often raised interest rates at the first sign of accelerating inflation, with price stability taking precedence over full employment as the central bank’s goal. This policy has hit low-income Americans the hardest.

Powell’s actions on this front are part of what led him – a Republican and former private investor – to gain the support of some prominent progressives such as former Labor Secretary Robert Reich and Representative Pramila Jayapal ( D-Wash.), Who heads the Progressive Congressional Caucus.

Yet the situation the Fed finds itself in is different from what it expected when it adopted the new policy in August 2020 to seek “broad and inclusive employment”. As part of the policy, the central bank said it would actually seek slightly higher inflation in pursuit of so-called maximum employment, a move enthusiastically greeted by activists who had long pushed the Fed to heed. the needs of low-income people.

The inflation plaguing the economy today stems more from supply chain bottlenecks than from the kind of healthy labor market dynamics – where employers have raised wages because so many people are already employed. – that the Fed was considering.

Wages are rising, but millions of people who had jobs before the pandemic are unemployed, with some held back by lack of child care or fear of returning to public jobs as the pandemic still rages on. The question now is how many of them will return before the Fed feels compelled to raise rates in response to inflation.

“Because inflation has become the primary concern, they are less willing to test maximum employment limits,” said Derek Tang, economist at Monetary Policy Analytics.

This has a few progressive groups on the edge. The Fed Up Campaign, a coalition of labor and community groups that has criticized the central bank’s past attempts to anticipate inflation, urged the Fed not to lose sight of its employment targets.

“Workers need the Fed to pursue macroeconomic policies favorable to jobs, wage growth and racial justice for as long as economic conditions allow,” the group said in a statement after the announcement of. the re-appointment of Powell. “The Fed’s mistakes gave us a ‘jobless recovery’ from the last recession, and it can’t happen this time.”

The Fed could be lucky next year if job growth continues at the current rapid pace – more than 1.3 million net jobs have been added to the economy over the past three months. This means the country could hit something that looks like peak jobs in the second half of next year, when the market expects rate hikes to start anyway.

“The Fed could potentially have a Goldilocks moment in the first half of next year where you still have reasonably strong growth, high inflation, but having reached full employment, so that creates the right conditions to raise rates. “said Dana Peterson, chief economist. to the Conference Board, a business research company that publishes economic indicators.

She added that if the Democrats’ $ 1.7 trillion social spending bill passed, it would give growth and inflation a further boost, giving the central bank even more leeway to return. higher borrowing costs without harming the economy as a whole.

But the home stretch towards an abundant labor market for all workers could prove to be much more difficult than the growth so far. Adam Ozimek, chief economist at the independent platform Upwork, said many companies are still returning to their pre-pandemic employment levels.

“It’s easy growth,” he said, adding that the economy needs to add more new businesses. “What comes next is more difficult.”

The Fed will also have to determine what “maximum employment” actually looks like, a target it has not set. The central bank’s business models have historically identified this as when job growth drives inflation to accelerate, but these signals are more difficult to analyze when supply issues are also fueling price increases.

Fed officials also noted that before the pandemic hit, unemployment reached 3.5% without triggering a significant rise in inflation.

“My sense of what people considered [maximum employment] to be is to go back to pre-pandemic employment levels, ”said Nick Bunker, director of economic research for North America at the Indeed Hiring Lab. He added that the economy could reach this stage next summer or fall. “But is going back to the pre-pandemic baseline necessarily the same as going back to peak employment? I am skeptical about this.

If the Fed is too eager to hike rates to fight inflation without letting the labor market reach its full potential, it could set a bad precedent, he said.

“This could make it seem like there is less dedication to the employment aspect of the mandate than it was in August 2020 when they drafted this framework,” Bunker said.

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