Fed Wanted an Inclusive Jobs Recovery. Some Are Asking If That Helped Fuel Inflation
(Bloomberg) -- In the first formal review of their policy strategy in five years, Federal Reserve officials are confronting a question that many outside the building have already taken up: Did their ambitious goals for a more inclusive job-market recovery after the pandemic slow their response to surging inflation?
For a lot of economists, the answer is clearly yes. To them, the last overhaul of the US central bank’s policymaking framework in 2020 reflected a shift in priorities toward maximizing employment at the expense of minimizing inflation. Others — including Fed Chair Jerome Powell — argue such assertions are based on a misunderstanding of the strategy.
Wherever the Fed’s 19 policymakers come down on this question, their conclusions will mark something of an official coda to the turbulent pandemic years and set the template for the central bank’s stewardship of the economy in part two of the Donald Trump era.
“The question ends up always having to come back to: How are Fed policies helping or hurting?” said Skanda Amarnath, executive director of Employ America. “That is something that the Fed could definitely make a lot of progress in ironing out through the framework review.”
Since 2012, the Fed’s rate-setting panel has each year approved a document known as its Statement on Longer-Run Goals and Monetary Policy Strategy. A kind of strategy declaration, it’s an agreed-upon approach for interpreting the rather vague legal mandates set for the Fed by Congress to pursue price stability and maximum employment.
In August 2020, the Fed concluded its first-ever official review of that strategy — an effort that had been launched before the onset of the pandemic but was also informed by unfolding events. At the time, the latest jobs report showed unemployment was above 10%, inflation was well below the central bank’s 2% target and millions of Americans had taken to the streets that summer in protest of the police killing of a Black man, George Floyd.
That was the backdrop for the Fed’s announcement coming out of the review that it would substantially redefine its congressionally-mandated “maximum employment” goal: Policymakers would, going forward, work only to avoid “shortfalls” from that goal — or in other words, situations where the unemployment rate was higher than where they thought it should be in the long run.
Previously, officials worried not just when joblessness was too high but also when it was judged too low. Importantly, the 2020 shift effectively ended a longstanding practice in which the Fed would begin raising rates preemptively when the unemployment rate was low to cool the labor market and ward off potential inflationary pressures before they materialized. It also nodded to the backlash against racial inequality that was reflected in the protests, officially stating that the maximum employment goal would now be defined as a “broad-based and inclusive” one.
Aggressive Interpretation
Some influential economists both inside and outside the Fed have since concluded that was a mistake. Christina Romer — who served as chair of Barack Obama’s Council of Economic Advisers — and her husband David Romer argued in a paper published in September that in the new framework, Fed officials embraced an “aggressive interpretation” of maximum employment, which kept them from raising rates in 2021 when inflation began accelerating.
“The narrative record suggests that the reinterpretation of the maximum employment goal played a crucial role in slowing the Federal Reserve’s response to rising inflation,” the University of California, Berkeley economists wrote in the paper, published by the influential Brookings Institution think tank in Washington.
A senior Fed staffer also published a critical paper last year. In it Michael Kiley, the deputy director of the central bank’s financial stability division, argued the focus on employment shortfalls “exacerbates economic volatility, worsens employment shortfalls and creates excess inflationary pressures” relative to the more preemptive strategy which it replaced.
Powell doesn’t seem to share that perspective. Speaking to reporters after the Fed’s most recent policy meeting on Jan. 29, he said the central bank’s slow response to inflation in 2021 was based on the belief that price increases would be transitory.
The Fed chief said the employment mandate would “be one of the many things that we discuss” in the 2025 review, which officials began considering at the January meeting and are set to conclude this summer. Minutes of the meeting to be published Wednesday could shed more light on their initial thoughts.
But Powell also defended the approach of not raising rates before inflation appears.
“Why would you preemptively want to put people out of work in the absence of any evidence that suggested that this was not a sustainable level?” he said. “I don’t think that insight is wrong.”
As economists take issue with the underlying strategy, the “broad-based and inclusive” branding may now also be under threat from politicians. The Fed quickly took steps to comply with an executive order from President Trump in January instructing federal agencies to end programs pursuing diversity, equity and inclusion in the workplace. For now, though, the central bank’s Statement on Longer-Run Goals and Monetary Policy Strategy retains the language.
Powell isn’t the only one still defending the 2020 framework. Others like Julia Coronado, founder of the research firm MacroPolicy Perspectives, draw a distinction between the strategy itself and the specific actions the Fed took in the moment.
After their policy meeting in September 2020 — the first following the announcement of the new framework — officials issued new and unusually detailed guidance stating they expected to keep their benchmark interest rate near zero “until labor market conditions have reached levels consistent with the committee’s assessments of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time.”
Too Specific
Even Powell has concluded in hindsight that their forward guidance may have been too specific.
“There’s the framework and then there’s how they operationalized the framework,” said Coronado, a former Fed economist. She sees room for policymakers to retain lessons from the 2020 framework review while also making it “more robust to different policy environments.”
The counterarguments from Powell and Coronado speak to the fact that the 2020 review was informed not only by the pandemic but also by the long recovery from the 2008 financial crisis, in which unemployment was high for many years and inflation was low. The last five years have been in many ways the opposite: A rapid labor-market recovery came alongside high inflation.
In 2023, the unemployment rate fell to the lowest level in more than five decades, reaping benefits for workers on the margins who are typically the last in line to partake in economic expansions. The jobless rate for Black workers dropped to a record low, and wage growth for the lowest earners outpaced overall wage growth by the most since the 1990s, by one Atlanta Fed measure.
Since then, some of those gains have reversed as the Fed has moved aggressively to bring inflation down. Charles Evans, the president of the Chicago Fed from 2007 to 2023, said he worries about the central bank backtracking on the employment goal now.
“You can easily imagine that because inflation has been above the 2% objective now for quite some time, and quite a lot, that there’s going to be more conservatism,” Evans said. “I think that that could come at a cost to employment, and employment longevity, for many people.”