There’s a strong case that the most important economic policy decisions of the past decade have been at the Federal Reserve. In the wake of the 2008 financial crisis, America’s central bank decided which troubled financial institutions would live and which would die, created a public option for short-term corporate financing, manipulated asset prices by creating artificial demand for various securities, provided an unlimited supply of dollars to some cash-strapped European nations (but not to others), and began deliberately suppressing economic growth in 2015, on the grounds that the U.S. could not sustain an official unemployment rate of below 5 percent without triggering runaway inflation.
All these decisions had profound consequences for the global economy; and that last one might very well have cost the Democratic Party the last presidential election by slowing economic growth in 2016.
And yet, the Fed’s policies attracted scant attention from the mainstream media or elected Democrats. An unthinking reverence for the central bank’s political independence kept the American public ignorant of — and unelected bureaucrats, unaccountable for — exercises of discretion that helped determine the availability of jobs, cost of credit, and distribution of wealth in the United States. Conservative Republicans may have been willing to threaten Fed governors with violence if they didn’t start fighting non-existent inflation — but liberal Democrats barely made a peep as Janet Yellen’s rate hikes needlessly jeopardized the job prospects of low-income workers (and Hillary Clinton).
Fortunately, the 2018 midterms brought some new Democrats to town. And the new generation is woke on monetary policy.
When Federal Reserve chair Jerome Powell testifed before the House Wednesday, Team Blue’s freshmen lawmakers posed some of the hearings most incisive questions.
Alexandria Ocasio-Cortez noted that over the past five years, the central bank had repeatedly suggested that unemployment could not fall much lower without triggering high inflation — only to see unemployment fall much lower without triggering high inflation.
Ocasio-Cortez: In early 2014, the Federal Reserve believed that the long run unemployment rate was around 5.4 percent. In early 2018, it as estimated that this was now lower, around 4.5 percent. Now, the estimate is around 4.2 percent. What is the current unemployment rate today?
Powell: 3.7 percent.
Ocasio 3.7 percent…Unemployment has fallen about three full points since 2014 but inflation is no higher today than it was five years ago. Given these facts, do you think it’s possible that the Fed’s estimates of the lowest sustainable unemployment rate may have been too high?
This exchange may sound dull and technical. But the congresswoman’s point has real human stakes. America’s central bank has a dual mandate: to promote full employment and price stability. How the Fed chooses to balance those two objectives has redistributive implications. The wealthy have far more to lose from inflation than they do from modest levels of unemployment. In fact, many business owners may actually prefer for the U.S. economy not to achieve full employment, since workers tend to be less demanding when jobs are scarce. By contrast, the most vulnerable workers in the U.S. — such as those with criminal records or little experience — will struggle to get a foothold in the labor market unless policy makers err on the side of letting unemployment fall “too low.”
And this is what AOC’s questions are implicitly about. If the Federal Reserve believes that the U.S. economy cannot sustain unemployment below 5 percent without suffering high inflation, then it will raise interest rates to cool off investment, thereby preventing too many workers from getting jobs. Ocasio-Cortez’s implication is that, by raising interest rates out of a fear of illusory inflation, the Fed may have needlessly hurt American workers. Powell’s concession on that point is significant, and suggests that the central bank will be less inclined to err on the side of hurting the vulnerable in the future.
AOC’s cogent questioning was well-received by economists on both sides of the aisle.
Rashida Tlaib asked an equally probing question. The Michigan congresswoman noted that during the financial crisis, the Fed had intervened in the commercial paper market to assist corporations. She then asked if the central bank would consider doing a similar favor for state and municipal governments in a future recession. The Roosevelt Institute’s J.W. Mason and Mike Konczal outlined the logic of such a policy in 2017:
Perhaps the single most powerful tool the Fed has to support aggregate demand and direct credit in socially useful directions is to purchase the liabilities of states, cities, and other subnational governments. This would greatly reduce the pressure for pro-cyclical cuts in public spending during recessions.
In other words, during recessions, mainstream economic theory suggests that the public sector should increase spending to make up for the shortfall in private demand. But because U.S. states and municipalities can’t run large deficits — and suffer revenue declines during recessions — they are often forced to cut spending during downturns, thereby reducing demand even further. The Federal Reserve could make it easier for states to avoid such cuts by buying up their debts.
Powell was flummoxed by Tlaib’s question and claimed that, while the Fed had the authority to help corporations in hard times, it did not have the legal power to do the same for state and local governments.
But Powell was (at least arguably) wrong.
Tlaib and Ocasio-Cortez did not “politicize” the Fed in a partisan sense: AOC was effectively pressuring Powell to pursue an accommodative monetary policy that would improve Donald Trump’s chances of reelection (or so, Trump himself seems to think). But they did call attention to the fact that the Fed’s decisions are inescapably political, especially in the context of recessions. Among other things, the central bank has the power to prioritize the interests of creditors and corporations — or those of workers and city governments. And if elected officials who are accountable to the latter constituencies never apply political pressure on their behalf, experience suggests that the Fed may give the former’s interests undue precedence.