Michael Meeropol: The Fed Sees No Danger Of Inflation
Does everyone know what THE FED is? It is the United States Central Bank. --- the official name is the Federal Reserve System. (The “system” consists of twelve regional Federal Reserve Banks which operate as a unit in terms of national policies but which are responsible for carrying out FED rules and regulations within their local districts.). Created in 1913, the FED had become by the 1980s the most powerful element in what economists call AGGREGATE DEMAND MANAGEMENT. That term describes actions by government entities to either slow down inflation or revive the economy when it’s in recession.
In all Principles of Economics textbooks there are sections describing the appropriate role for government in a mixed economy like the United States. The most basic role is to enforce contracts and protect individual rights --- including the property rights of those individuals. An economy that is organized through the use of markets (uncoerced interactions between buyers and sellers) could not be sustained if contracts were unenforceable. Imagine what it would be like making deals only with people you could physically dominate to force them to abide by the terms of the deal. That’s why all market economies have police and courts.
Other roles for government include maintaining competition (that’s why there are anti-trust laws), providing for social goods and services like the military, public education, fire departments, and redistributing income (as in our social security system, public welfare, etc).
A more complicated role involves altering what the market system would do without government intervention to subsidize some activities and restrain others. The reason for doing this is that often the signals sent by markets --- the prices charged for goods or services --- don’t accurately reflect the benefits and/or costs to society. When I buy gasoline, I do not pay for the damage done by the exhaust that comes out of the tailpipe which can make people sick and ultimately raises the temperature of the earth. Similarly, when I take a train ride on Amtrak between New York City and Washington, DC, the benefit to society as a whole is much higher than my benefit as reflected in the price I am willing to pay. All the cost savings because there is either one less car on the road or less people flying in airplanes between the two cities are not counted in the price of the train ticket. That is why gasoline is taxed and why Amtrak is subsidized.
This brings us to Aggregate Demand Management. This is the most recent addition to the national government’s economic responsibilities. Before the 1930s, no reputable economist would have argued that it was the government’s responsibility to stimulate the total demand for goods and services by intervening in the activities of the market. When the economy fell into periodic crises (called depressions then --- we now call them recessions) the goal was to just wait it out, let prices and wages fall until the economy corrected itself. Even if the periods of depression were long (as occurred, say, in the 1870s in the United States) they ultimately self-corrected – at least that was the conventional wisdom within the economics profession.
In the middle of the Great Depression of the 1930s, John Maynard Keynes blew up this conventional wisdom with his book The General Theory of Employment, Interest and Money. He argued that there was no self-correcting mechanism and that therefore the government had to step in whenever total (aggregate) demand was weak and unemployment was rising. In the United States, this commitment was made through the passage of the Employment Act of 1946.
[There is a very interesting book called Congress Makes a Law, The Story Behind the Employment Act of 1946, by Stephen Kemp Bailey (NY: Columbia University Press, 1950) which details how a law originally proposed as the Full Employment Act of 1945 was significantly watered down so that when it was finally passed it mandated that Congress take action to provide for “high employment” with “stable prices” (without defining those terms). The law also required that all actions had to be consistent with the free enterprise system.]
In 1978, with the passage of the Full Employment and Balanced Growth Act, the goals were made more specific. Both the federal government (through the budget process based on proposals by the President and passed by Congress) and the FED were tasked by Congress to pursue a “DUAL MANDATE.” Specifically, there was a goal of 4 percent unemployment (which has morphed into “maximum employment”) and stable prices.
[Pursuant to that act, the FED must report to Congress twice a year on actions it has taken to achieve the goals of that law. Reports are available at https://www.federalreserve.gov/monetarypolicy/mpr_default.htm ]
In the years since the passage of the Full Employment and Balanced Growth Act, the FED has set a goal of keeping inflation at around two percent (on average). Despite the fact that the economy rarely hits its numerical target, the FED still has a goal of achieving an unemployment rate as close to the “magic number” of four percent as possible.
[This “magic number” was defined by the Council of Economic Advisers in 1961 as the “full employment” level of unemployment. Since there are always people just entering the labor force or between jobs, any unemployment rate lower than that was deemed “too low” and liable to produce an acceleration of inflation. Over the years, by the way, that “minimum” was thought to be drifting higher. Some economists argued, especially in the 1980s that the appropriate target for unemployment was closer to six percent. Currently, the target is back at four percent, which the economy had achieved before the current pandemic-induced recession.]
Unfortunately, for a variety of reasons, the FED has mostly failed to get unemployment as low as four percent. According to annual data, there have been only THREE YEARS since 1978 when that rate was four percent or below.
[The Federal Reserve Bank of St. Louis has a marvelous collection of economic statistics that can be accessed just by googling FRED. The specific graph of annual unemployment rates going back to 1948 (seasonally adjusted) is available at https://fred.stlouisfed.org/series/UNRATE#0.]
Despite the failure to hit that target, whenever unemployment has surged during recessions, the FED has hopped to the task of responding by attempting to stimulate the economy. Their main tool is to cut the Federal Funds Rate which is the rate banks charge each other for short time (sometimes as short as overnight) loans. The FED sets a target, announces that target, and then takes action to hit that target. (The FED committee that actually does that is the Federal Open Market Committee [the FOMC].)
Beginning in 2008, the great financial crisis produced the Great Recession ---- unemployment maxed out at 10% in October, 2009---. The FED engaged in extraordinary efforts --- including pushing the Federal Funds Rate to near zero and keeping it there until December, 2015.
With the advent of the pandemic in early 2020, the Fed cut the Federal Funds Rate to near zero again (in March). It has remained there ever since and in recent speeches the Chairman of the Fed has made clear that until they see signs that the economy has fully recovered, they will not raise that rate.
[For a report on the most recent meeting of the FOMC, see Alex Cook and Lauren Perez, April 2021 Fed Meeting – Fed Maintains Rates Amid Speculation About Future Inflation Concerns, available at https://www.magnifymoney.com/blog/news/fed-meeting/.]
I consider the FED’s recent attention to the unemployment part of its dual mandate very welcome indeed. When Howard and Paul Sherman and I wrote our textbook on Macroeconomics, we complained that the FED had mostly privileged the fight against inflation --- shirking half of its “dual mandate” --- the half promoting maximum employment.
[For our discussion of Monetary Policy and the FED, see Sherman, Howard, Michael Meeropol and Paul D. Sherman, Principles of Macroeconomics, Activist vs. Austerity Policies, 2nd Edn. (NY and London: Routledge, 2019): chs. 22 and 23.]
But the recent increased government activity to promote “maximum employment” produced the inevitable backlash.
(This response by political and business leaders and too many economists was foreshadowed by the Polish economist Michal Kalecki. In 1943, he penned an article “The Political Aspects of Full Employment,” in the Political Quarterly, available at https://delong.typepad.com/kalecki43.pdf in which he warned that if the government made the unemployment rate “too low” there would be great political pressure applied to force the government to “back off.” Kalecki’s reasoning was based on the Marxist view that owners of business make their profits by extracting “surplus value” from their workers. One of the ways of doing that is to keep wages low. However, with unemployment low, workers have more bargaining power and wages therefore tend to rise. Kalecki’s conclusion is that whenever government takes action to reduce unemployment, business leaders are sure to use all their political influence to force the government to back off. In the modern era this manifests itself in the demonization of Federal Budget Deficits.)
Sure enough, in recent weeks, there have been rumblings that the economy is in danger of “over-heating” because of all that federal government spending --- extra unemployment compensation, various other elements of the American Rescue Plan --- and because of all the government spending in the recently proposed budget and the Jobs Bill and the Families Bill. Reviving the demonization of federal budget deficits is an important example of the zombie economics that I highlighted in my last commentary.
The good news is that in recent statements, both Secretary of the Treasury Yellen and Chairman Powell of the Fed have argued that there is virtually no danger of sustained inflation as a result of the big increases in federal spending. In fact, Powell made clear that for the foreseeable future, it is important that the rate of inflation EXCEED the FED’s goal of 2 percent because of all the recent years when inflation was below that number.
The most important fact emphasized by Powell is that the economy is still about 8 million jobs short of the total employed before the pandemic induced recession last year. With that much unemployment, the danger of an acceleration to inflation is almost nil.
As I argued in my last commentary --- the complaints about too much government generosity to ordinary citizens is a vicious class-based assault on the standards of living of working people. Too many of our fellow citizens believe it’s just wrong for workers to be able to tell their potential bosses that they won’t work unless they are paid well. On the contrary, I think we all should celebrate rising wages. Promoting maximum employment which is the key to rising wages and therefore an increased standard of living is much more important than restraining inflation.
Michael Meeropol is professor emeritus of Economics at Western New England University. He is the author with Howard and Paul Sherman of the recently published second edition of Principles of Macroeconomics: Activist vs. Austerity Policies
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