State of the Union, Roosevelt’s Take: Bold Actions Taken by the Fed Have Advanced the Economy, Not President Trump

January 31, 2018

Donald Trump misses no opportunity to boast about the strength of the U.S. economy in his first year in office. And it’s true: There has been some good news recently. Business investment spending is rising again, after years of stagnation. Unemployment is down, and the share of the population with jobs has gone up—which shows it was wrong, a few years ago, to blame the whole fall in employment on structural causes like demographics or lack of skills. Thanks to a strong labor market, workers’ share of the pie is rising for the first time since the end of the 1990s. In the corporate sector, labor’s share of value added is up (and profit’s share down) by about two points over the past three years.

But these developments are not grounds for self-congratulation. They only begin to reverse the much longer trend in the opposite direction. (Yes, the labor share has risen in the past few years, but it’s still lower than it was a decade ago—and much lower than at the end of the 1990s.) But they do show that expansionary policy works. Despite fears of robots or China, it is clear that a high-pressure economy still encourages investment and strengthens the bargaining position of working people, just as it has in the past. There’s every reason to think that if the economy continues to run hot, wages and employment will continue to rise and productivity growth will pick up.

The Republicans will be tempted to take credit for these developments. They shouldn’t. Businesses don’t invest—and certainly don’t raise wages—because of tax cuts. They invest when demand for their products is strong. They give raises when a tight labor market forces them to—when they can’t otherwise get the workers they need.

While Trump and Congress can’t take credit for today’s relatively strong economy, the Federal Reserve (the Fed) does deserve some recognition. While they could have done much more, the extraordinary steps taken by Ben Bernanke, Janet Yellen, and their colleagues during the recession and its aftermath undoubtedly did help keep money flowing through the economy at a critical moment.

The danger today is that the Fed will reverse course and try to shut off growth just when ordinary Americans are beginning to see the benefits. Monetary policymakers are still in thrall to the idea that low unemployment will lead to runaway inflation, no matter how many times these predictions have proved wrong in the past. The experience of the past few years shows that the labor force is not fixed: strong labor market draws people deemed unemployable back into the workforce. And when labor scarcity does lead to raises, they’re not passed on to prices but encourage productivity-boosting investment, or else come out of profits—leveling a playing field that for many years has been tilted toward owners. Unfortunately, too many at the Fed still see low unemployment as a problem to be solved. If the Fed stays on its current course of raising rates and shrinking its balance sheet, it could discourage productivity-raising investment, doom millions of people to insecure, undercompensated employment, and close off any chance of a real recovery from the Great Recession.

For a decade now, inflation by the Fed’s preferred measure has come in below their 2 percent target, even as unemployment has fallen well below the non-accelerating inflation rate of unemployment (NAIRU), or “natural” rate at which inflation was supposed to take off. This consistent failure—understating the benefits of expansion and overstating the danger of inflation—should have taught Fed policymakers some humility. Unfortunately, it’s not clear that it has. Right now, a majority at the Fed seems set on throwing millions of Americans into the very real misery of unemployment to combat an inflation threat that exists only in their imagination.

The tweeter in chief may like to take credit every time a company announces it’s investing in a new plant or adding employees. But if we’re looking for policymakers whose decisions directly affect economic outcomes—for better and for worse—we might do better to focus our attention on the Federal Reserve.