For most of the past four decades, the Federal Reserve has been an ally of deficit hawks and adversary of full employment.
Faced with the stagflation crisis of the 1970s, the central bank developed a new economic orthodoxy that would reign supreme for nearly half a century. This doctrine held that the U.S. economy required a substantial amount of unemployment at all times in order to properly function. The Fed’s reasoning was straightforward: When labor markets grow exceptionally tight, it is difficult for employers to replace their existing workers with unemployed ones. That gives the already employed the leverage to extract raises from their bosses in excess of their own productivity; bosses will then respond by raising prices; workers will respond to price hikes with even more excessive wage demands; and runaway inflation will ensue.
Therefore, to protect price stability and the dollar’s value, the Fed made a practice of raising interest rates — which is to say, increasing the cost of credit so as to deliberately slow down the economy — whenever the unemployment rate threatened to fall below the level it deemed “natural.” Meanwhile, the central bank generally comported itself as an advocate for fiscal restraint on Capitol Hill. After all, if Congress perennially passed deficit-financed handouts to working people, consumer demand could push unemployment below the desired level, triggering inflation.
Thus, although Bill Clinton campaigned for the presidency on plans to increase federal spending and promote full employment, Fed chair Alan Greenspan effectively vetoed that platform once he took office: If the president did not demonstrate his commitment to reducing the deficit, Greenspan warned, then the central bank would have no choice but to steeply raise interest rates to keep a sufficient number of Americans involuntarily unemployed. Decades later, fears of excessive employment still haunted the central bank’s halls: In 2015, Democratic Fed chair Janet Yellen began raising interest rates to deliberately “cool off” the economy and slow job growth because all serious policy wonks believed that if the unemployment rate fell below 4 percent, runaway inflation would ensue.
But today, the Fed’s economic orthodoxy has fundamentally changed. And its role in American politics has changed with it.
Under Jerome Powell’s leadership, the Fed has internalized decades-old progressive critiques of its policymaking. Among them: The central bank is not capable of discerning the maximum level of employment that is consistent with price stability before the fact, and has consistently underestimated this rate, actively reducing growth and hurting millions of vulnerable Americans in the process; allowing demand to run needlessly low undermines the economy’s productive capacity by causing discouraged workers to exit the labor force and/or lose valuable skills; and full employment is an indispensable tool for promoting racial equality, as it is only in an exceptionally tight labor market that the most disadvantaged and stigmatized categories of workers can secure economic opportunity.
In deference to this analysis, the Fed has become a cheerleader for — and accommodator of — progressive fiscal policy. Whereas Greenspan nipped Clinton’s spending plans in the bud by threatening to raise interest rates, Powell has abetted Biden’s agenda by promising to keep rates low, even in the face of bond-market consternation.
This week, Powell reiterated the central bank’s accommodative posture. When the Fed released its last forecast for interest rates back in December, it projected no hikes until 2024. Since then, the vaccine rollout has proceeded at a faster-than-expected pace, Congress has appropriated another $2.8 trillion worth of fiscal support, and investors have begun demanding higher yields on long-term Treasury bonds. This led some observers to expect a change in the central bank’s outlook. But on Wednesday, Powell once again disappointed inflation hawks. Although the central bank did make an upward revision to its expectations for economic growth in light of the new stimulus, it did not alter its forecast for the cost of credit: It still does not expect to raise benchmark rates above near-zero until 2024, and will not raise them even if inflation exceeds 2 percent for a short period before then. Rather, the Fed will wait until price growth hits an average of 2 percent over the course of a whole year before it begins throwing some cold water on the expansion.
There isn’t much reason to expect that the United States will see such inflation before 2024. The end of the pandemic is likely to witness a surge in demand for various in-person services that the public-health crisis rendered hazardous or unavailable. Airfares and hotel-room prices are poised to spike. But as Matt Klein notes in Barron’s, a rise in the price of such services should be partially offset by declining demand for durable goods:
While used-vehicle prices had jumped 14 percent between February and October as many consumers switched away from public transit to driving, preowned-vehicle prices have since dropped by 4 percent … Similarly, the prices of major appliances surged 16 percent between February and November. Many people who had been thinking about upgrading their living situation were suddenly flush with cash thanks to the combination of federal income support and closed services businesses, and they spent accordingly — before producers had a chance to ramp up supply. But prices have drifted lower since then as consumers sated their demand and as manufacturers boosted capacity.
Thus, Congress can probably take the Fed’s forecast at face value: It will be able to borrow money at near-zero interest rates for at least the next two years.
For the White House, though, Powell’s editorializing may have been even more valuable than his accommodative policy.
Moderate Democrats live in terror of being perceived as licentious, spendthrift liberals. Which is why they long for Biden’s policies to be validated by at least some Republicans. In the past, the Federal Reserve would exacerbate centrist Democrats’ anxieties — and stoke their thirst for bipartisanship — by endowing center-right orthodoxy with the status of technocratic truth. Now, it is doing the opposite.
Jerome Powell is a white male Republican, a multimillionaire, a career investment banker, and appointee of Donald J. Trump. And he has used the (unwarranted) “credibility” that these demographic characteristics, professional background, and partisanship afford him to brand progressive fiscal policy as bipartisan common sense.
On Wednesday, Powell praised Congress for passing Biden’s American Rescue Plan, saying that it is “going to wind up accelerating the return to full employment.” But he suggested that the $1.9 trillion package was nevertheless insufficient.
“What it takes to drive productive capacity … to raise living standards over time is investment — investment in people’s skills and aptitudes, investment in plant and equipment, investment in software,” Powell argued. “What Congress has been doing is mainly replacing lost income; there should be a longer-term focus on the investment front.”
In other words: Congress should pass another spending package comprising productivity-enhancing public investments — like, say, the one the White House is currently preparing.
Nancy Pelosi and Chuck Schumer have touted Powell’s endorsements of fiscal expansion incessantly for the past year. And they will surely capitalize on his latest remarks when herding moderates in the coming weeks. After all, if America’s highest-ranking Republican technocrat supports a multitrillion-dollar infrastructure bill, what business does a centrist Democrat have in opposing it?
If Biden succeeds in passing another major spending package, and making the American Rescue Plan’s temporary expansions of the welfare state permanent, a wide variety of structural forces and political actors will deserve some measure of credit. But the happy accident that was Donald Trump’s decision to hand the Fed chairmanship to Powell — rather than to one of the myriad austerity mongers in the conservative monetary policy firmament — should rank high on any list of why American economic policy isn’t as self-destructively cruel as it used to be.