In a historic break with decades of policy, the Federal Reserve announced Thursday that it will no longer deliberately keep millions of Americans unemployed at all times.
America’s central bank has a dual mandate — to promote full employment and price stability. These two aims were long presumed to be in tension: If unemployment fell too low — such that there was no slack in the labor market (i.e., no reserve of jobless workers for employers to draw on) — then workers would gain the upper hand on their bosses and demand wage gains in excess of their own productivity, which would force companies to raise the prices of their goods to keep up with their labor costs, which would then cause workers to demand still-higher wages to keep up with prices, in a vicious inflationary cycle.
For this reason, the Fed defined “full employment” as an unemployment rate significantly above the level one would expect from mere job-switching frictions. And when the labor market tightened beyond the level the Fed deemed conducive with price stability, it would start raising interest rates — to choke off credit creation, slow growth in the money supply, and thus, deliberately keep Americans out of work — even if inflation had not yet exceeded its official target.
This operating procedure had significant 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.”
In the aftermath of the Great Recession, the inequity of the central bank’s longtime prioritization of avoiding theoretical inflation — over the certain unemployment of millions of workers — became more conspicuous. The Fed’s official inflation target is 2 percent. But for a variety of reasons — among them, the tepid pace of the recovery and the weak bargaining power of American workers in an age of trade-union decline — price growth remained stubbornly below those levels, even as the central bank kept interest rates near zero. Nevertheless, despite the absence of any hint of excessive inflation, the Fed began raising interest rates in 2015, on the grounds that the U.S. could not sustain an official unemployment rate of below 5 percent without triggering a wage-price spiral.
Progressive (and a few growth-oriented conservative) economic-policy wonks pushed back on this move. Then, when a Republican president with a penchant for easy money came to power — and the GOP’s inflation hawks went dutifully silent — Trump’s appointed Fed chair, Jerome Powell, adopted a more accommodative stance. And America proceeded to learn that its economy could not only abide a 3.6 percent unemployment rate without suffering runaway inflation, but that such a rate wasn’t even sufficient to bring inflation to its target level of 2 percent. The theorized hard trade-off between unemployment and price stability did not appear to exist, which meant that America’s finest economic minds had been slowing growth and killing jobs for no good reason.
These developments prompted the Fed to conduct a review of its monetary-policy strategy. And on Thursday, Jerome Powell made the two main conclusions of that review official:
(1) The Fed will no longer presume that it knows what the maximum level of employment in the U.S. economy is, and will therefore refrain from raising interest rates until there are clear signs of excessive inflation.
(2) The Fed will not treat its 2 percent inflation target as a maximum, but rather as the average rate it wishes to promote over an extended period of time. Which is to say: If inflation runs a bit below that target for years on end, then the Fed will tolerate inflation a bit above that target for a few years after.
In one sense, this announcement just formalizes the Fed’s current approach. And the fact that the central bank will tolerate higher than 2 percent inflation — when it wasn’t able to engineer such inflation during the post-2008 expansion, let alone, during the current crisis — may seem trivial. But the policy does influence investor expectations and is likely to push the Federal Reserve into a more pro-growth, pro-employment stance at the margin. The next time inflation hawks call for rate hikes amid 4 percent unemployment and tepid-to-moderate inflation, Powell’s official policy will put them at a disadvantage.
As significant as the rule itself might be, Powell’s rationale for it acknowledges the maximization of employment as an objective with profound stakes for inequality and social justice. Speaking of what the Fed learned from its consultations with community and labor groups, Powell said Thursday, “The strong labor market that prevailed before the pandemic was generating employment opportunities for many Americans who in the past had not found jobs readily available. The clear takeaway from these events was the importance of achieving and sustaining a strong job market, particularly for people from low- and moderate-income communities.”
In its immediate, concrete impacts, the Fed’s policy is borderline negligible. But ideologically, it affirms a paradigm shift in how monetary policy is conceived at the elite level. Since the stagflation crisis of the 1970s, the dominant view of the Fed’s role was as a check on the profligacy of our government’s elected branches: Its primary job was to snuff out inflation before a spendthrift Congress sent it spiraling out of control. And it could do this by dispassionately identifying and targeting the natural rate of unemployment.
This view is now outmoded. In the wake of the 2008 crisis, Congress didn’t impair national prosperity by indulging in too much deficit spending; it did so by tolerating too little. If there is a “natural” rate of unemployment, the Fed is manifestly incapable of identifying it. And in a context where labor lacks the capacity to extract significant wage gains even when the labor market is tight, the Fed feels compelled to acknowledge that its policy decisions are not actually apolitical. There is no one universally optimal monetary policy, which is dictated by impartial data. All Fed policies are made by human beings amid great uncertainty, and how the bank chooses to balance competing risks and imperatives will benefit some segments of society, while hurting others. By acknowledging this reality, Powell has made it a bit easier for America’s working-class majority to prevent its ox from being gored.