Behind the Numbers: Powell Backs Down

August 28, 2019

The Fed was in the news this past week, partly for its annual Jackson Hole conference, partly for some impolitic comments by a former official, but mainly for its recent decision to not lower interest rates. Most observers had expected that the cut in rates this spring would be followed by another cut this time.

For professional Fed watchers, the main concern is that changes in the Fed’s interest rate have strong effects on asset prices—lower rates mean higher bond prices, a weaker dollar, and so on. So, financial market participants have an obvious reason to worry about decisions made by the Fed.

But what about those of us who are more concerned with the interests of working people?

Most obviously, we should be disappointed. There are real questions about how powerful monetary policy is at directing the economy. But to the extent that it has any power at all, we would like it to be pushed in the right direction. And there is good reason to think that the right direction now is toward more demand, which means lower rates.

While today’s historically low unemployment rates lead some to fear an overheating economy, the official unemployment rate almost certainly understates the amount of slack in the economy. Most obviously, inflation remains below the Fed’s target of 2 percent. The labor force participation rate among working-age adults is also low by historical standards, as is the wage share of national income. It’s true that labor force participation rates have risen somewhat in recent years, and wage gains have picked up, especially at the low end. But these welcome developments only show that relatively strong demand is finally starting to bear fruit. (They also suggest that there was more space to raise demand than we thought—meaning policy was too tight in recent years.) We need a much longer period of strong growth to make up for the very weak demand in the years after the 2007 financial crisis. This calls for more expansionary monetary policy—that is, lower rates.

Meanwhile, there are already signs that the economy is weakening. There has been much attention to the inverted yield curve—an unusual pattern where longer-term interest rates are lower than short ones—which has developed in recent months. Historically, this has often predicted a recession. And the Bureau of Labor Statistics recently made drastic downward revisions in its estimates of employment growth for the first half of the year—also often a sign that a downturn is coming.

There’s no guarantee that we’ll see a recession in the next year or two, let alone a deep economic crisis like 2007-2009. But if we’ve learned anything from the past decade, it is that macroeconomic policy needs to consider not just the most likely outcome but the balance of risks. The dangers of deep demand shortfalls are much greater than the dangers of overshooting.

One thing that’s clear now is that some people at the Fed have not, in fact, learned anything.

Not only did the Fed not lower rates this time, but recently released minutes from the previous meeting shows that many members of the Federal Open Market Committee—the Fed’s policymaking body—were strongly opposed to cutting them then. Since then, a number of Fed officials have come out publicly against further cuts. The last recession led to years of severely depressed demand and high unemployment, with immense social and economic costs. But a significant minority of Fed decisionmakers evidently still see insurance against a similar disaster as less important than guarding against the phantom menace of inflation or “normalizing” interest rates as an end in itself.

For progressive activists and advocates, one lesson should be clear: The Fed’s choices are fundamentally political, as some members of Congress understand well. Appointments to the Fed are not just about credentials and technical expertise. We shouldn’t accept the idea that Fed chairs will remain in office from administration to administration, regardless of party. There’s nothing wrong with asking presidential candidates if their appointees to the Fed will prioritize strong growth and full employment.

A more subtle point is the difficulty that the Fed has reaching consensus. Some people have argued that any weaknesses in conventional monetary policy can be overcome by committing to adopt looser policy in the future. It should be clear—if it wasn’t already—that the Fed cannot influence conditions today with promises to do something years from now. Powell can’t even commit his colleagues to decisions in three months. Forward guidance won’t work. If monetary policy is not up to the job, we need to give central banks a better toolkit. Or else give fiscal policy a larger role—which means first agreeing that when demand is weak, there’s nothing to fear from bigger government deficits.